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How This Income Method Works Well In Good Times And Bad



  • We regularly write about multi-basket income strategies. They mostly have the same underlying principles but vary in terms of income needs, growth goals, and risk levels.
  • We wanted to analyze and give readers a view of how they would have fared during this unprecedented crisis if they were invested in one such diversified strategy.
  • To remove the bias from results, we would assume that we started this strategy as of 1st January 2018, giving the strategy enough time to stabilize and then going into the current crisis. We will compare the results with the S&P 500 index.
  • We also provide long-term back-testing results going back to 2008, which includes the 2008-2009 recession.
  • Looking for a portfolio of ideas like this one? Members of High Income DIY Portfolios get exclusive access to our model portfolio. Get started today »

We regularly write about the importance of not only diversifying in stocks but also diversifying in terms of strategies and types of assets. As such, besides growth, we focus on income-producing strategies, especially strategies that also preserve capital during times of crisis. Preservation of capital is probably one of the most important factors for retirees and conservative investors. In order to preserve capital, it's important that our overall portfolio is able to achieve low volatility and smaller drawdowns, while not compromising on growth during the good times.

We can have all the talk about capital preservation, but the real test comes when the market takes a huge dive in real-time, something akin to what we have seen recently due to the coronavirus pandemic. An event or correction like this can act as a real eye-opener to review and judge if your portfolio is meeting its defined goals.

We wanted to analyze our three-basket strategy and give readers a view of how they would have fared if they were invested in one such broad-based strategy.

The strategy we will pick for testing and comparison is similar to one of our most popular from many articles that we have published in the past and can be found here, here and here. We will pick the beginning date of the portfolio as 1st January 2018. The S&P 500 index was around the 2750 mark at the beginning of 2018, slightly below where it is hovering right now. Moreover, these past 28 months, even though not a very long time, does include two sharp corrections. The first one happened in the fourth quarter of 2018 but was followed by a quick V-shaped recovery. The second correction, of course, is the current one, which is still unfolding. As such, our benchmark is the S&P 500, so

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This article was written by

Financially Free Investor is a financial writer with 25 years investment experience. He focuses on investing in dividend-growing stocks with a long-term horizon. He applies a unique 3-basket investment approach that aims for 30% lower drawdowns, 6% current income, and market-beating growth on a long-term basis and he focuses on dividend-growing stocks with a long-term horizon. He runs the investing group High Income DIY Portfolios which provides vital strategies for portfolio management and asset allocation to help create stable, long-term passive income with sustainable yields. The service includes a total of 10 model portfolios with a range of income targets for varying levels of risk, buy and sell alerts, and live chat. Learn more.

Analyst’s Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, UNH, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, ARCC, AWF, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, PCI, PDI, PFF, RFI, RNP, STAG, STK, UTF, VTR, WPC, 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.

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.

Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.

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Comments (57)

NV_GARY profile picture
@Financially Free Investor
"For example, this year, the market peaked on Feb. 19 before declining, our model switched to TLT as of March 2."

It looks like QQQ was doing the best in the 3 months prior to your switch- why go to TLT?

Financially Free Investor profile picture
@NV_GARY Thank you for reading and the question. So, that's not correct. At the end of February, over the previous 3 months, TLT was showing >10% gain, while QQQ was up less than 1%.
It was entirely possible, that the downturn would have started on 1st of March, then we would have waited an entire month to switch. But then in the long term, these things sort out themselves.
Pacman13 profile picture
Thank you for your work here. I like the concept. Perhaps I am missing something though. If the Basket 2 using QQQ/TLT and SPY/TLT gets 9-12% returns, why would you use the Bucket 3 of CEFs with target of 8% with as mentioned no downside protection? It may be difficult to get 8% income but I think using preferreds and some fixed income vehicles you could get 6% with significant less risk.
KKane profile picture
Thank you for the well written article. what assumptions did your analysis make about the income the combined portfolio made? Did it sit in cash, or was it reinvested? If reinvested, I am curious how and when.

Thanks again.
@Financially Free Investor Thanks for the article. Nice approach, with quite limited volatility, which I think is appreciated by more investors given the events of the last 60 days. Two questions: (1) have you thought about using preferred shares in place of the CEF portfolio? They (typically, if wisely chosen) produce very stable income and generally have pretty stable prices as well. (2) is there a mutual fund (or ETF or CEF) that executes the rotational strategy? The reason I am asking is that I think there are behavioral economics issues that can sometimes make it difficult to pull the trigger on the rotation at times, but having some other mechanism do it automatically for you might be helpful. It would also help when we get older and perhaps have less cognitive capacity (or die and leave the assets to someone who is less financially savvy). I suppose there are some automated mechanisms offered by some brokerages that might do the trick too. But my preference would be to find a low cost mutual fund that does the rotation for me. Any thoughts?
@Financially Free Investor, thank you for a clear and helpful article. Can you give us the "neutral" setting for basket 2, and the ranges you go to for the two securities (e.g. 30-70)?

riddix profile picture
Why is NMZ classified as a utility ?
Financially Free Investor profile picture
@riddix - It is by mistake, needs to be municipals. Thanks for pointing out.
Nick Ackerman profile picture
Interesting how that is the first thing I noticed too and then was the first comment I saw. hah!

@Financially Free Investor good article and interesting portfolio setup!
GoRetireSmart profile picture
@Financially Free Investor Thank you for the well thought out and interesting article! I have one question though. In looking over the performance of the three buckets, why not just be 100% invested in bucket #2 (RA strategy)? That seems to give the best overall result with the least volatility. Why include the other two buckets if one does only a single yearly draw-down/withdrawal?
Financially Free Investor profile picture
@GoRetireSmart - Thank you for the comment. Just the old saying "don't put all your eggs in one basket".. Future can be different than the past. But I would say this. In my opinion, the first two buckets are very good in the long-term, and each has distinct advantages. The only bucket that can be optional is the CEF-income if one does not need or care about income.
Arbitrage- Technologies profile picture
some cohen and steers fund RNP and others distribute 9pc div. how is that possible when average underlying distribute aorund 6.5pc??? be carefull
Fast Track to Financial Independence profile picture
That's the equity CEF business model. The difference comes from leverage, and/or option-writing, and some dose of distributing tomorrow's stock market gains today. The latter can work in moderation, but is disastrous in excess.
El Contador Inversor profile picture
Certainly don’t know whether we will get another market dip or a V recovery. However went to Home Depot this morning. Parking lot was absolutely packed. During this entire process they’ve been open but nothing like today’s crowds. Sure seems to be pent up demand.
Thanks for an very interesting and well researched article.

Withdrawing about 5- 6% per year okay, but some of those assets pays dividend as well, so I don't quite understand it? Is the 5-6% withdraw including the dividend.

Financially Free Investor profile picture
@Kyed - Yes, that would include dividends or distributions. Thanks.
In your Basket 2, Part 1 how are you measuring volatility?
Financially Free Investor profile picture
@seek2945 - We measure the volatility of the two securities over the previous one month. Volatility measurement is the "standard deviation" of the daily variations over the specific period. Thanks.
Thank you.
ruediklein profile picture
Good article. Coming from twenty years of cap-weighted global indexing with little to show for, I have looked at the Income Factory and your bucket approach and have settled on the buckets. Since I started investing in the high yield portion end of last year and really getting into it in the short run-up in February, I have been taken to the cleaners.
The high yield portion is the riskiest part of the buckets. It therefore makes the most sense to actively manage it, i.e. rotate out of, when the potential loss exceeds the 8-10% yield, wouldn‘t you agree?
Further, I am wondering who this portfolio approach is for? Surely, the folks on SA won‘t sit around evaluating their portfolio only once a month, when all hell just broke loose? Instead, when things are volatile weekly monitoring and action would improve the performance.
As such, one could improve on the rotation indicator as well, perhaps a combination of Trend Following and STC would have gotten one out before any significant losses.
Stay safe, Ruedi
Financially Free Investor profile picture
@ruediklein - Thank you for the comment. I agree, in our 3-basket system, the High-Income (CEFs) is least safe and has no downward protection. That's why we recommend allocating a small portion of your portfolio. So, the question is why to allocate at all? The idea is to generate a lot of income from a small part of the portfolio.
Btw, our CEF-portfolio is down -21% YTD compared to -11.60% for S&P500. But if you exclude the MLPs, it is in much better shape. Our DGI is down -9.80% YTD. Our Rotational portfolios are either in positive territory (as much as 20% up) and a couple of them are negative by just 2%.
So, it is important to mix them in the right proportions to make the overall portfolio conservative and safe. Hope this helps.
John R. Clark profile picture
Good day to all. Thanks again to our host author for a key quote with application beyond the scope of today's feature. Namely, "Preservation of capital is probably one of the most important factors for retirees and conservative investors."

My own self calls it definitely THE most important, given how the more capital you lose or waste, the less remains to generate future income. As for young investors who took paper losses in this year's crash (like all the rest of us), but stood fast instead of panicking --- many compliments. You hold the same capital or assets as before, only with diminished value for now. Keep it, PRESERVE it, add to it, and your capital will again multiply.

Proverbs 13:11 (New English Bible) reads:

"Wealth quickly come by dwindles away,
but if it comes little by little, it multiplies."

Some translations open with "dishonest gain" --- ignorantly in my view, as if sudden wealth never came by lawful means but only from cheating and stealing. Who hasn't heard of life insurance, inheritances, gifts, timely invention of, say, the Hula Hoop, timely purchase and sale of Hula Hoop shares, or just picking the right lottery number?

So be it for now. We all know of someone who came upon a large sum only to lose it all from ill- preparedness. Yet this proverb, correctly read, not only states the nature of a thing but also instructs how to thwart its tendency. First, be mindful of that. First also, don't wait or dream for sudden wealth, but build your own little by little. This is all most people can do to start, via a 401(k), IRA, or similar means. But this works when you do it. This also teaches you how greatly a large sum ever received would multiply if placed and held right. Wealth quickly come by need not dwindle.

Ideally, parents would teach their youngsters the virtue of thrift and saving, without leading them ever to count on a monetary windfall. In reality, many adults will receive their first wise counsel from a mentor, co-worker, friend, or remote trainer such as Dave Ramsey. From whomsoever, this never comes too early and better late than later. I have been privileged to advise 4 or 5 parties on financial choices, mostly related to spending.

In a household keeping life insurance to support a widow(er) and orphan(s), the spouse in charge should make sure of the other's being grounded in basic finance, with names of several reputable parties to call for help. Money acquired this way can dwindle fast from unpreparedness, or when used rightly will serve as a base for ever- growing wealth.

A balanced financial portfolio, built and well tended over decades, with or without sudden increases, makes great assurance for one's best years.

Thanks to all for reading. Keep wise and well!
Financially Free Investor profile picture
@John R. Clark - Thank you for sharing the wisdom. All the best.
Good article. What do you think about using ETJ or one of the Eaton/Vance funds to help limit the downside in Bucket3.
galicianova profile picture
Truly nice and simple!
Flashback9 profile picture
Good work. Thanks for writing this.
Financially Free Investor profile picture
@Flashback9 - Thank you for reading. All the best.
cm schwab profile picture
Very nice read thank you for posting. 🙂👍
Financially Free Investor profile picture
@czbbcl - Thanks, appreciate the comment.
I just upgraded to Premium. Does that mean I get the key to the acronyms? DGI? RA?
Financially Free Investor profile picture
@tulasubway - Thank you for the comment. I am sure you will get used to DGI (Dividend Growth Investing) very soon, as it so commonly used on SA. However, RA is just a term used for Risk-Adjusted in the context of Rotation strategies, I guess I used the full form also in the article. Best.
Thanks for sharing.
Diamond-Hands profile picture
Awesome article with good data to back it up.

Not sure I am conservative enough to adopt this plan, but given my disastrous results this year, maybe I should.
Financially Free Investor profile picture
@$Das Kapital - Thank you for the comment. All the best.
The title of the article says it’s an income method but I didn’t see anything saying the returns were calculated assuming any income withdrawals. I’d like to see the analysis including monthly withdrawals similar to what a typical retiree may desire, say like 4%, 5%, and 6% ($40K, $50K, $60K annually). I think it makes a significant difference in the performance when these distributions are not being reinvested.
Financially Free Investor profile picture
@12tb3 - Thank you for the comment. We did not include the graphs with income withdrawals, in order to avoid the article getting too long. But there are links to 3 previous articles which include income withdrawal examples. One can comfortably withdraw 5% income (maybe even 6%) from this strategy without impacting the portfolio performance/growth. The reason this strategy can handle income withdrawal much better than S&P500 is the lower volatility and much smaller drawdowns. Hope this helps. All the best.
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