The Ultimate Income Portfolio: 7.1% Yield with Low Risk

October 14, 2014

by Geoff Considine

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In July of 2010, I introduced a portfolio-construction strategy called the Ultimate Income Portfolio (UIP). I have updated that strategy annually, revising the holdings and reviewing the previous year’s results. (Here are the results for 2011, 2012 and 2013.) My goal is to provide the maximum available yield while diversifying to reduce risk. I set a target risk, which is within the range that most individual investors seek. I also sell covered call options against portfolio holdings to increase income.

In this article, I analyze the performance of last year’s Ultimate Income Portfolio and generate the UIP for 2014-15. The result is a portfolio that yields 7.1% with a risk level equivalent to a 70/30 stock/bond index fund. I also explore some of the lessons learned from four years of tracking and revising the portfolios.

Background

Some investors focus on the yield generated by their portfolios rather than on the expected total return. Typically, they prefer to use the income provided by their portfolios, without relying on principal, to reduce the possibility that they will have to sell assets during market declines. Relying only on portfolio income should eliminate the possibility of exhausting portfolio assets.

But the income generated by a portfolio may fluctuate and may not keep up with inflation. Relying only on income does not mean that an acceptable level of income will be generated. For those investors who are weighing the costs and benefits of an income strategy, as well as for those who prefer income to capital appreciation, it is crucial to understand how much income is available at acceptable risk levels.

The four previous iterations of the Ultimate Income Portfolio have been implemented in increasingly difficult conditions for income seekers. The Fed has kept interest rates on Treasury bonds at or near record lows. As a result, the available yields from almost every asset class have dropped. Many income investors have invested in riskier asset classes including equities, real-estate investment trusts, master-limited partnerships (MLPs) and lower-grade bonds to achieve levels of income that were available from Treasury bonds in past decades. The silver lining to this environment is that inflation has also remained low, so that there is less incremental loss of purchasing power.

The good news from the past four years is that it has remained possible to generate high levels of income with risk levels consistent with those chosen by many individual investors. Even as the very low-interest-rate environment has persisted and market valuations have trended higher, there are attractive income portfolios.

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