Retirees: Carefully Traversing The Income Balance Beam

by: Adam Aloisi


Low yields from both stocks and bonds have created a challenging income investment environment.

Creating a personal portfolio balance won't eliminate risk, but should mitigate it.

Defining, finding and building your balanced portfolio.

With income investors seeing historically low yields in both equities and bonds, the challenge to create a safe, yet adequate stream of cash flow has never been greater. While many retirees may be uncomfortably accepting heightened capital risks by utilizing equities for income, a prudent personal portfolio balance should help to mitigate the sleepless nights that unanticipated market conditions and stock volatility might bring.

S&P 500 Yield - Last 20 Years

What Is Proper Balance?

While investment firms, banks, and other securities outlets interested in selling you something, but not really interested in getting to know you, may offer wholesale asset allocation recommendations or blanket strategies, I wouldn't put much stock in them. Sixty percent this, 40% that, may be effective for some, but for most, something a bit more sophisticated will be necessary. And once comfortable asset allocation or balance is achieved, it's not something to set and forget. Reallocation of general asset strategies and rebalancing of specific securities should be conducted on as regular a basis as is practicable.

Changing economic, interest rate, and equity market times call for different allocation strategies. If the 10-year Treasury were trading at a double digit yield like it was 30 years ago, compared to today's 2.5%, do you think you'd have a bit more exposure to the bond market? And with yield attainment over time and inflation protection an important theme for today's retiree, strategies such as dividend growth have rightfully gained in popularity. But will they be so popular if the Fed embarks upon a tightening spree?

10 Year Treasury Yield

So proper allocation balance and/or security strategy will be a variable concept for individual retirees, predicated on available capital, living cash needs, risk tolerance, and current market conditions, amongst other considerations. Though portfolio balance shouldn't change drastically on a day to day basis, over time it could and probably should migrate as asset and sector risk/reward gyrates, and security specific valuations wax and wane.

Finding Your Proper Balance

For most, the pursuit of balance could be an ongoing process of trial and error. While my sense is that many have gotten rather brave with their equity allocations over the past five years given a rather rampant bull run, it can be easy to forget or not realize the fear that can envelop the market in a sharp downturn. Those who think their risk tolerance is higher than it really is could find out the hard way when they live through a sharper or longer duration market correction than the last five years have brought forth.

Of course if one positions themselves as a true income investor, they might be able to shrug off market volatility, falling back on the fact that positions are continuing to churn out income even if paper capital loss is occurring. Still, no strategy is necessarily bulletproof when the economy turns, so complacency should be avoided at all costs.

Thus, over time, retirees should be able to position income portfolios with a balance of dividend production, payout growth, and capital stability that not only helps to meet personal goals but also protects against periodic bouts of fear and/or sleepless nights.

Building Your Income Balance

As I'm oft to iterate, an income investor should err on the side of over diversification as opposed to under diversification when it comes to crafting a portfolio. If you have ten 10% positions or five 20% positions, you are taking much more risk than by owning fifty 2% or a hundred 1% positions. Though income disruptions seem to be few and far between over the near-term, a blindside dividend cut or elimination would be a much more negligible event for the more diversified investor.

Insofar as specific stock selection goes today, the low yield environment has created somewhat of a minefield for those looking to establish an income program. Many dividend growth consumer non-durable favorites, including the likes of P&G (NYSE:PG) and Coke (NYSE:KO) yield in the 3% range, and might not meet the immediate needs of most investors with modest nest eggs. Given their attributes, these companies tend to sell with premium earnings valuations which may not make them acceptable buys here for many.

I would argue that companies with less of a dividend growth history, lower valuations, and lower payout ratios like Cisco (NASDAQ:CSCO) and Apple (NASDAQ:AAPL) will provide for a more robust income build over the next decade. There is probably more business risk here, so a stylistic combination of established, higher payout consumer names and "new kid on the block" lower payout equity choices may make sense.

If you couple lower yielding names with more aggressive income plays from more esoteric securities such as option income closed-end funds that yield close to double digits, you may be able to create blended investment pairings that yield in the 5-7 range. The typical downside of elevated yield products is that they don't grow income in a robust manner like dividend growth stocks. Thus thoughtful decisions between instant and delayed gratification must be made.

One can find higher yields in business development companies and mREITs like Prospect (NASDAQ:PSEC), Fifth Street (FSC), and American Capital (NASDAQ:AGNC), but operational complexity and economic sensitivity make them volatile on a capital and/or income level. Thus, they may not be appropriate for many retirees.

And then there are always "tween" yielding equities in the 4-6% yield range with many C-corps and REITs fitting that bill. Some of the companies currently sitting in that range include Realty Income (NYSE:O), Altria (NYSE:MO), and utilities like PPL.

Finally, while they continue to be frowned upon by most pundits, I always advocate a variable positioning to bonds. Surprisingly, with the 10-year Treasury having dropped 50 basis points this year, bonds have performed quite nicely, although I'd certainly be a bit more cautious at this juncture. My advice is typically to invest in individual issues when looking at investment grade bonds and consider closed-end high yield funds trading at a discount. My favorite there right now is Prudential Global Short Duration High Yield (NYSE:GHY), yielding better than 8 percent.

So depending on what one's yield requirement is, there is more than one way to skin the cat, as they say.


Though retirees are up against some pretty stiff challenges in a ZIRP environment, there are ways to build an effective, yet prudent income portfolio given current risk-free limitations. Creating and visualizing proper diversified portfolio balance is key, with a constant forward view towards income need and security specific risk, and a peripheral view to macro factors that can and will influence a portfolio.

Disclosure: I am long MO, PSEC, FSC, GHY, PPL, CSCO, AAPL. 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.

Disclaimer: The above should not be considered or construed as individualized or specific investment advice. Do your own research and consult a professional, if necessary, before making investment decisions.