4 ETFs For Constructing An Income Portfolio

Includes: EMHY, JNK, NLR, PFF, REM
by: Matthew D. McCall

In a world where investors receive 1.68% annually for lending the U.S. government money for ten years and the average one-year CD pays 0.75%, it is not a surprise that investors are searching for better yields.

After listening to investors for the last two years complain about the low-yield environment I decided to start a new service that builds an all-ETF portfolio based on the number one goal of providing income to investors. The one mistake many investors make is that they concentrate solely on the dividend yield of the ETF. While the yield is important for obvious reasons when attempting to build a portfolio that generates above-average income, it can also be deceiving.

An example is the Market Vectors Nuclear Energy ETF (NYSEARCA:NLR), which has a yield of 13.4%. That would sound very attractive to most yield seekers, however the stock is down nearly 20% in the last 12 months as the S&P 500 has gained 20%. The yield does not make up for the 40% difference in returns in one year.

Constructing the Portfolio

In general I will suggest investors build a niche portfolio such as this one based on income, with approximately ten positions with 10% of the allocation in each ETF. The goal is to concentrate on income and at the same time diversify across various sectors and asset classes.

My ETF income portfolio currently has eight ETFs and approximately 19% in cash for any new investment options. The portfolio yields just under 6%, more than triple the 10-year treasury yield.

Four Income ETFs

Sharing four of the ETFs in the portfolio to give investors an idea of my methodology is a good primer to get started on constructing your own ETF income portfolio.

The highest yielding ETF in the portfolio is the iShares FTSE NAREIT Mortgage Plus ETF (NYSEARCA:REM). The ETF invests in a basket of mortgage REITs that have been hot commodities with interest rates remaining near historic lows. The ETF is trading at a 52-week high and continues its slow move higher along with its current 11.3% dividend yield. The ETF charges an expense ratio of 0.48%.

The iShares S&P U.S. Preferred Stock ETF (NYSEARCA:PFF) is also trading at a new yearly high as it moves along like a tortoise in both up and down markets. The ETF is currently yielding 5.7% and the expense ratio is 0.48%. With preferred stocks being hybrids of stocks and bonds, but taking the best of both asset classes it makes PFF very attractive. The ETF tends to move with stock prices, though with a lower beta and offers yields well above treasuries. This is a win-win situation.

The iShares Emerging Markets High Yield Bond ETF (BATS:EMHY) is a basket of below investment grade bonds issued by corporation and sovereigns based in the developing countries. The ETF currently has its highest exposure to Turkey, Venezuela, and the Philippines. The yield is 5.8% and the annual expense ratio is 0.65%. The ETF is fairly new, launching in May of this year, but it is trading at its best level since its debut. The emerging markets off a rare opportunity for bond investors because of their solid financial standing as well as higher than average yields.

The SPDRs Barclays Capital High Yield Bond ETF (NYSEARCA:JNK) is a widely popular ETF with over $12 billion in assets and a yield of 6.1%. The high yield or junk portion of the corporate bond market has been able to move higher with the equity market and at the same time continues to offer big-time yields. JNK has been a ETF my firm began buying in early 2009 and still hold to this day. Amazingly the ETF is not lagging the S&P 500 by a large portion when all dividends are included in the performance. The ETF charges an expense ratio of 0.40%.

There are four of the ETFs in my income portfolio service that offer diversity across sectors, geography, and asset classes. This is a good start, but investors must realize there are many more options available depending on specific goals and risk tolerance. I have given you step one, the next few steps in the process are now on your back. Good luck.

Disclosure: I am long JNK, PFF, REM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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