Income Seekers: DIY Or No Assembly Required?

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Includes: IYLD
by: Matt Tucker, CFA

It's a typical investor conundrum these days: How do you balance the need for income with the risk required to get it? In this low interest rate environment, people are increasingly looking to higher risk asset classes in order to meet income objectives – as evidenced by significant flows into instruments such as high yield corporate bonds.

But it's never prudent to put all your eggs in one sector, particularly when that sector carries volatility and default risk with it. Instead, investors would be wise to consider building a diversified, multi-asset class portfolio designed to deliver yield. Diversification in and of itself can reduce overall portfolio risk, especially when a portfolio is diversified not only across securities but also across asset classes.

ETFs have long been a great tool for building this kind of portfolio. With the ever-increasing selection of ETFs offering more and different exposures, investors are better able to fine tune portfolios, adapting to specific goals such as increasing yield while managing risk. Around here, we often compare ETFs to those plastic toy building blocks your kid might play with. Just as you can combine different bricks to create various structures, so can groups of ETFs be combined to help meet portfolio objectives. So, for example, an investor wishing to balance yield with risk might use a combination of ETFs that offer exposure to high yield bonds, REITs, and dividend-paying stocks.

What about the investors that don't have the time or inclination to manage such a portfolio? Now ETFs offer a tool for that, too. One such example is a newer ETF, the iShares Morningstar Multi-Asset Income Fund (BATS:IYLD). IYLD is a pre-assembled solution – an ETF comprised of other ETFs with the objective of delivering yield from diversified sources. Unlike an actively managed fund, where a manager is making investment selections, IYLD tracks an index that balances risk through diversified asset allocation. (See a breakdown of the differences between ETFs and mutual funds here).

For illustrative purposes only.

Some details about IYLD: The asset allocation is set at 60% fixed income, 20% equity, and 20% "alternative" income sources (e.g. preferred stocks and REITs). While the asset allocation remains static, the index is updated quarterly, and the weights for the underlying ETFs that represent each asset class are chosen based on correlation, returns, yields and volatility. Only iShares ETFs that meet size, liquidity, and income objectives are considered. The result is a portfolio that currently has 9 iShares funds and over 2,000 underlying securities that tend to generate income (for a full list of index rules, see here).

Of course, there are those that prefer to be the architect of their own "building block-land," so to speak. For them, ETFs provide the tools to do so. But for those that want a one-ticker solution for the problem of finding income, IYLD may be an appropriate play.

Disclosure: No positions

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