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I consider the day I retire from my nine-to-five job and live off of dividend checks the highest pinnacle of investing success. To that end, I am actively building an income portfolio that will eventually allow me to retire comfortably. For weeks I have been reading articles on Seeking Alpha trying to find ideas regarding the stocks that should comprise a solid investment portfolio, and I have been surprised by the core stocks recommended by other authors because of the low yields these stocks offer.

Most articles suggest investing in blue-chips with a history of raising dividends; however, I propose that the core of an investment portfolio should be comprised of the highest yielding dividend instruments. Let’s analyze Colgate-Palmolive (NYSE:CL) as an example. This company has raised dividends for 47 consecutive years and now pays 2.32% annually, but this return does not even keep up with inflation during most years. I propose that the core of any income portfolio should not be shares of stock but shares of Real Estate Investment Trusts because of their significantly higher dividends.

Real-Estate Investment Trusts (REITs), like American Capital Agency Corp (NASDAQ:AGNC), pay up to 18.5% in dividends annually. With this high return, almost one fifth of one’s investment will be returned each year, which means one could live off dividends much sooner than if investing with a portfolio core of high-yield blue chips.

When creating the model portfolio (listed below), I selected five REITs with the highest dividends and invested heavily in residential mortgage pass-through securities for which the interest and principal are backed by U.S. government entities (Fannie, Freddie, and Ginnie).

  • American Capital (AGNC)
  • Annaly Capital. (NYSE:NLY)
  • Capstead Mortgage Corp. (NYSE:CMO)
  • Hatteras Financial Corp. (NYSE:HTS)
  • ARMOUR Residential REIT. (NYSE:ARR)

These five REITs offer a combined yield of 16.71% as of August 3, 2011. It would be much easier to live off of $16,710 for every $100,000 invested versus $2,320 returned from the same amount invested in Colgate-Palmolive.

What’s even better than a REIT’s yield is the tax advantage they offer provided they continue to give 90% of net income to share-holders. As a tax accountant I have seen first-hand that managers are motivated by tax incentives, and I am confident this tax advantage will continue to produce income for shareholders in the years to come. I am sure I know more than a couple of Apple’s (NASDAQ:AAPL) investors who wish Steve Jobs did that!

Contrary to what you may be thinking there is a place for blue-chips in my income portfolio. In fact, this part of the portfolio is very important for people who are expecting to draw income from this portfolio for many years to come. The blue-chips I look for will provide strong growth for the portfolio while also providing a strong yield. I have picked two blue chips for this portfolio: Verizon (NYSE:VZ) and AT&T (NYSE:T).

Verizon has a dividend yield of 5.5% and just received the rights to distribute and provide service for the Apple iPhone. This distribution/service agreement has already contributed to AAPL’s bottom line, they beat consensus earnings estimates by $1.94 in the second quarter and I am expecting strong growth for Verizon as time goes on and they continue to write service agreements for the iPhone.

Then there is AT&T. The hardest thing to look past on AT&T is their cell phone business. I would even consider this the ugly duckling of my portfolio. We have all heard the rumors:

  • The cell phone business was on the ropes until AAPL stepped in and took a large position in exchange for the exclusive rights to distribute and service the iPhone.
  • That people will be switching from AT&T to Verizon now that the iPhone is available on Verizon’s network
  • That the service is a questionable at best, Consumer Reports just rated AT&T as the worst cell phone service provider in the US.

That was just all yesterday. Today AT&T realizes what it must do and has begun to make itself competitive without maintaining exclusive rights to the iPhone. They have begun by doubling the number of cell-towers in the Midwest, starting in Chicago. They have also begun new national advertising campaign to change the way consumers view their service.

Then there is AT&T’s high point: U-Verse! Not only is their market-share in pay-for-television growing every quarter (65% for last year alone) because of this bundling service, it has breathed new life into their land-line service. The changes in their cell business as well as their U-Verse bundle of landline phone service, Internet, and pay television service will make this a growth stock to own for years to come, all with a 6.07% dividend at the time this article was written.

Below is my ideal income portfolio:

REIT/Stock

Yield

Percent Capital Allocation

AGNC

19.66%

15%

NLY

14.99%

15%

CMO

14.99%

15%

HTS

14.74%

15%

ARR

19.17%

15%

VZ

5.5%

10%

ATT

6.07%

10%

This portfolio has a total yield of 14.525% per year. That is awesome considering that it not only contains five REITs with cashflow protected by government sponsored entities, but it also has two blue chip stocks that are poised for high dividends and growth for years to come.

The REITs mentioned above should be the core of any income producing portfolio and will continue to produce double digit income for many years to come. Those core REITs should be supplemented with high-yielding blue chips with the catalysts for growth so that we can all retire early and comfortably with large dividend checks for many years to come!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Source: My Ideal Dividend Portfolio: Mostly REITs Coupled With High-Yielding Blue Chip Stocks