Just Retired? Combine These Strategies To Earn Solid Income With Less Risk

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Includes: BDC, CVS, D, DWX, HQH, HYG, IEF, JNJ, JPC, KYN, LMT, MAIN, NMZ, O, OHI, PCI, PDI, PEP, PFF, PG, PM, QQQX, RFI, RNP, STK, T, TSN, UL, UTF, VLO, VZ, WFC, XOM
by: Financially Free Investor
Summary

If you've just retired and wondered where can you earn a decent income while preserving your capital? Please read on.

After ten years of bull market, the markets are showing signs of old age and exhaustion. Will the current environment morph into a full-blown correction or the bull-run will continue?

Even though Bank CD yields have improved lately, but they barely meet inflation. Bond funds are in danger of losing value due to a rising interest rate environment.

We offer three strategies when combined, they are reasonably safe, suitable for the medium to long-term, can provide solid income while preserving capital, all at the same time.

For retirees, one of the major challenges of the last several years has been finding a sustainable income stream. Even though the rates on Bank CDs (Fix-Deposits) have been improving, but they are still far too low to provide a good stream of income. In fact, at current rates, they barely protect you from the inflation. So, after counting inflation, there is really no income left to spend. There is uncertainty about the safety of Bond-funds since they are at risk of losing value in a rising interest rate environment. Sure, there are many other securities or funds out there that promise big incomes but fall short on the safety of capital.

The stock market has been in a bull market for the last ten years, though of late for the last two months, it has been in turmoil. We have seen 10% correction twice in 2018. Currently, the market is range-bound, and it is hard to predict which way it is headed.

Irrespective of the market direction, there is always a fear among the newly retired, or anyone who is going to retire soon, about the market's big drops and corrections. No one would like to see their investments going down 30% or even more within a short span of time. It can especially be devastating to retirees who are in a withdrawal phase and not in a position to add new money. On the other hand, if you let fear overtake you and continue to remain in cash while the bull market may continue for another two years, you could lose a big chunk of gains. Just for example, by 1997-98 the S&P 500 had gained nearly 100% in the previous three years but still continued to gain another 50% in the next two years. Also, we know from history, the bull-market spans are much longer than a typical bear market.

You just retired, now what?

Let's say you are 62 years old and just retired with $750,000 in total savings, a vast majority of which is in mutual funds inside your 401K account -- where do you go from here?

Most likely, when you retired, you were not sitting on 100% cash. Maybe, until now you were just invested in the mutual funds that were available within the 401K. In another scenario, you may have been invested in a bunch of ETFs and some individual stocks, but with no clear strategy or downside protection. Maybe your investments do not generate enough income, and you do not know what to sell and when. Either way, you need a clear strategy with definite goals, income needs and most important downside protection based on your risk tolerance.

There are three goals that we can clearly define:

  • We want to avoid any serious bear markets and huge drawdowns at all cost. In a worst-case scenario like 2008-2009, we want to see a maximum drawdown of 15-20%. Essentially, we want downside protection.
  • We want to take part in a bull-market scenario to be able to get reasonable growth for the long-term health of our portfolio and investments.
  • We want to generate enough income that we can withdraw and use for expenses in retirement, without much need to sell shares.

Our solution to meeting all of these goals is to invest in a set of three diverse strategies. In this article, we will discuss three different strategies with unique goals, distinct risk levels, and income targets. However, when combined, they can provide 5-6% income with market-matching or higher overall returns, while providing safety and preservation of capital.

Portfolio Structure:

To set up three different portfolios of the kind that we will discuss in this article, it requires some initial work and ongoing management. However, in our opinion, the benefits definitely outweigh the time and effort required. The table below shows how we will structure an overall portfolio of $750,000, divided into three sub-portfolios, or let's call them three buckets.

Bucket/Portfolio

Portfolio Initial

Amount

Total Return targets

Income withdrawn

Effort level

1.

DGI Portfolio

$250,000

(33.33% of total)

10%

Dividend

Income 4.0%

=$10,000

Initial setup, thereafter minimal

2.

CEF Income Portfolio

$200,000

(26.67% of total)

10%

Distribution

Income 8%

=$16,000

Some effort during the first year, thereafter minimal

3.

Risk-Adjusted Rotation Portfolio

$200,000

(26.67% of total)

10%

Withdrawals 6%

=$12,000

On-going effort on a monthly basis

4.

Cash/CDs/Money-market

100,000

(13.33% of the total)

2.5%

Income 2.5%

=$2,500

Insignificant

TOTAL

$750,000

9.0% (average)

Yearly Income = $40,500 (5.4% average)

Author's note: We provide some of these strategies and portfolios in our Marketplace Service " High Income DIY Portfolios."

If you are a retiree and depend on the income generated by this portfolio, considering an investment capital of $750,000, an income of $40,500 is reasonable, but may not suffice to pay the bills. However, by adding other income sources like social security payments or pension income, this can add to a substantial income. If we were to add $36,000 yearly income from social security for a couple, the total disposable income would become $76,500. Let's say that you have been a very diligent saver and saved a million dollars in investable assets; the income would jump to roughly $54,000 yearly. After including social security payments of $36,000, it gets to a very comfortable sum of $90,000 a year.

Bucket/Strategy 1: DGI

For this portfolio, we should select at least 20 companies (preferably up to 30) with an average portfolio yield of roughly 4.0%. All of the companies should be dividend paying and have substantial dividend history. For this article, we will select 20 companies from various sector/industries, representative of most sectors/industries:

Stock Symbol

Company Name

Industry

dollars

Yield (12/12/2018)

Amount

CVS

CVS Health Corp (CVS)

Retail/Pharmaceutical

$12,500

2.68%

$335

D

Dominion Energy, Inc (D)

Utility

$12,500

4.44%

$555

DWX

S&P International ETF (DWX)

Int'l Dividend ETF

$12,500

4.51%

$564

ENB

Enbridge Inc

Energy/ Pipelines

$12,500

6.96%

$870

JNJ

Johnson & Johnson (JNJ)

Healthcare/Drugs

$12,500

2.45%

$306

LMT

Lockheed Martin (LMT)

Defense

$12,500

3.01%

$376

MAIN

Main Street Capital Corporation (MAIN)

Business Dev. (BDC)

$12,500

6.23%

$779

O

Realty Company (O)

REIT

$12,500

4.07%

$509

OHI

Omega Healthcare (OHI)

REIT/Healthcare

$12,500

7.28%

$910

PEP

PepsiCo (PEP)

Beverages

$12,500

3.17%

$396

PFF

iShares US Preferred ETF (PFF)

Preferred ETF

$12,500

5.76%

$720

PG

Procter & Gamble (PG)

Consumer Staples

$12,500

3.05%

$381

PM

Philip Morris (PM)

Tobacco

$12,500

5.44%

$680

T

AT&T (T)

Telecom

$12,500

6.63%

$829

TSN

Tyson Foods Inc (TSN)

Consumer/ Food

$12,500

4.00%

$500

UL

Unilever (UL)

Consumer Staples

$12,500

3.29%

$411

VLO

Valero Energy Corp (VLO)

Energy/Refinery

$12,500

4.35%

$544

VZ

Verizon (VZ)

Telecom

$12,500

4.21%

$526

WFC

Wells Fargo (WFC)

Finance/ Banking

$12,500

3.60%

$450

XOM

Exxon Mobil (XOM)

Energy Major

$12,500

4.31%

$539

TOTAL/ AVERAGE

$250,000

4.47%

$11,180

Bucket/Strategy 2: High Income CEFs

The main purpose of this bucket/portfolio is to provide high income. We will invest in 10 different CEFs (closed-end funds) but in four installments. Each time we will invest only 25% of the total amount (earmarked for this bucket). The four installments can be invested with a gap of a quarter or six months, depending on the individual's situation and risk profile.

For the sake of illustration, here is a sample/example:

  1. First Investment in Jan. 2019 - 25% of this bucket capital
  2. Second Investment in April 2019 - 25% of this bucket capital
  3. Third Investment in July 2019 - 25% of this bucket capital
  4. Fourth Investment in Oct. 2019 - 25% of this bucket capital

The ten CEFs are selected in such a way that they are invested in different asset classes, including equity, options-based income, fixed-income, debt securities, utilities, REITs, BDCs, etc. Overall, the resulting portfolio will be quite diverse.

Please note the majority of the CEFs use some amount of leverage, usually between 20% and 40%. This leverage helps them generate higher levels of income than other investments. But as they say, leverage can work both ways, and that's why these investments are considered riskier than say a DGI stock. But this bucket is only 26% of our total portfolio, so the risk is limited. Moreover, our back-testing models indicate that this portfolio is no riskier than the overall market, at least on a long-term basis. Our prior work on this can be seen in our other articles, which provide some evidence of the robustness of such a portfolio.

Symbol

Security Name

Type of CEF

Amount

Yield

Amount

1

HQH

Tekla Healthcare Investors (HQH)

Health Care

$20,000

9.68%

$1,936.00

2

JPC

Nuveen Pref & Income Opps Fund (JPC)

Preferred

$20,000

8.83%

$1,766.00

3

KYN

Kayne Anderson MLP (KYN)

Energy MLP

$20,000

11.98%

$2,396.00

4

NMZ

Nuveen Muni High Inc Opp (NMZ)

Utilities

$20,000

5.79%

$1,158.00

5

PCI

PIMCO Dynamic Credit Income (PCI)

Debt & Mortgage securities

$20,000

8.66%

$1,732.00

6

PDI

PIMCO Dynamic Income Fund (PDI)

Debt securities

$20,000

8.63%

$1,726.00

7

RFI

Cohen & Steers Tot Ret Realty (RFI)

Realty

$20,000

7.98%

$1,596.00

8

RNP

Cohen & Steers REIT & Pref (RNP)

REIT/Pref

$20,000

8.12%

$1,624.00

9

STK

Columbia Seligman Premium Tech (STK)

Technology

$20,000

9.76%

$1,952.00

10

UTF

Cohen & Steers Infrastructure (UTF)

Infrastructure

$20,000

8.62%

$1,724.00

TOTAL/ AVERAGE

$200,000

8.81%

$17,610.00

Bucket/Strategy 3: Risk-Adjusted Rotation Portfolio

There can be several strategies that one could employ. We provide two examples below.

An Income Oriented Rotation Strategy with QQQX:

We are essentially looking for a portfolio which meets the following objectives:

  • Provides protection during nasty market corrections and limit the drawdowns.
  • Provides high growth during stable or bull-market environment.
  • Generates roughly 5% income on a consistent basis.

Most portfolios can meet one (or maybe two) of the above goals but it is tough to meet all three at the same time. Our Income-oriented Risk Adjusted Portfolio attempts to meet all three objectives.

We will use three securities in this portfolio:

  1. (QQQX) Nuveen Nasdaq 100 Dynamic Overwrite Fund
  2. (HYG) iShares iBoxx High Yield Corporate Bond ETF
  3. (IEF) iShares 7-10 Year Treasury Bond

QQQX has a reasonably long history going back to January 2008, which incidentally covers the last recession. It invests mainly in the top 100 Nasdaq stocks. We will provide the back-testing results using the QQQX/IEF/HYG. Since QQQX is a CEF and provides distribution of 7.90%, we will likely generate a substantial income whenever we are invested in QQQX.

HYG is the high-yield bond and also provides distribution of roughly 5.25% on a monthly basis.

Every month, we will compare the relative performance of these securities over the previous three months. We will select only one security that has performed the best for the next month's investment. We will repeat this process on a monthly basis.

Since January 2008, this strategy has provided an annualized return of 14.54%, compared to 8.12% if we were invested in S&P500. However, the big difference is really in the drawdowns. The strategy had a drawdown of only about -16% compared to a whopping drawdown of -48.5% in case of S&P500 and -46% for QQQ.

Performance Chart - QQQX Rotation Strategy vs. S&P500:

The first chart shows the performance in $$, whereas the second chart shows in yearly returns.

Here is a snapshot of performance comparison (from January 2008 - Nov. 2018) of our Rotation strategy with Nasdaq-100 index and S&P 500 index.

Strategy Name

Securities used

Annualized Performance

from 2008-2018

Max. Drawdown

Rotation Strategy: 3-Months Relative Performance (with income)

Using

QQQX /IEF/HYG

14.54%

-16.23%

NASDAQ-100 Index

(Buy & hold)

QQQ

12.63%

-46.06%

S&P 500 Index

(Buy & hold)

SPY

8.12%

-48.47%

Alternate Strategy: Highly Conservative 401K/IRA Rotation-Based Portfolio:

The details of the Conservative 401K/IRA Rotation-Based strategy can be seen in our previous article here.

Conclusion

We agree that deploying and maintaining a 3-bucket portfolio is some work, especially in the beginning. It may also look complicated at first glance. We also recognize that some folks may not have enough time; others might not have an interest or sufficient desire. However, if you want to take control of your investments and not worry about every 5% drop in the market, it could be worth the time and effort. It does not have to be all or nothing, or a sudden change in approach; rather, one should make a gradual change.

We believe in diversification not only in terms of investment in multiple stocks but also in terms of different assets and strategies. At times, when one asset class or strategy zigs, some other will zag. The multi-basket portfolio as presented above will balance out the income flow and improve overall returns while minimizing the drawdowns.

Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. The author is not a financial advisor. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. The stock portfolios presented here are model portfolios for demonstration purposes.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, WMT, WBA, CVS, LOW, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, HCP, HTA, O, OHI, VTR, NNN, STAG, WPC, MAIN, NLY, ARCC, DNP, GOF, PCI, PDI, PFF, RFI, RNP, STK, UTF, EVT, FFC, HQH, KYN, NMZ, NBB, JPS, JPC, TLT. 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.