Q&A – High Yield Portfolio Ratio
In Retirement, what percentage of allocation would you recommend between high yield holdings (for immediate income) vs. dividend growth stocks to keep with inflation?
Capital preservation and inflation beating income is the goal.
This is a very interesting question. It’s often thought of in order to maximize the retirement income, or in situations where it’s actually needed.
Yield Categorization
Before I provide my thoughts, we need to categorize yield. Here is how I approach it.
- Over 6% is a risky yield (unless there is a market crash)
- Between 4% and 6% is high yield (company has consistent excess cash)
- Between 2% and 4% is normal yield
- Under 2% is low yield with higher company growth
The reader asking about high yield was looking for a yield betweeb 5.5% to 7%. That’s a risky yield if you follow my guidelines above. Sure, there are products offering those yield but there is always a yang to the ying.
There is a statistical norm to yield and there is a reason why it’s risky for a corporation to pay over 6% consistently year after year. Paying a very high yield puts a lot of pressure for a company to maintain it.
Usually, companies will have a lower sustainable yield and if there is excess cash, they initiate a share buy-back program. Both are good for investors but they send different signals.
The Ground Rules
In order to outline the ratios, it’s important to know where you stand with a 4% income rate. Since 4% is often used as a withdrawal rate, I am going to use 4% as an income yield for retirement.
Here is a table to show you numbers you should have. Those are gross numbers and I will leave you to do your own taxes.
| Yield | Annual Gross Income | Total Portfolio |
| 4.0% | $40,000 | $1,000,000 |
| 4.0% | $48,000 | $1,200,000 |
| 4.0% | $56,000 | $1,400,000 |
| 4.0% | $64,000 | $1,600,000 |
| 4.0% | $72,000 | $1,800,000 |
When you look at the above and you are close to retirement, there are 2 variables in your control; the yield and the portfolio value. However, growing the portfolio value by hundred of thousands is not easy and is often out of reach.
As such, the yield is often what investors want to push upward to increase the annual income. Say you push it up to 4.5%, you get the following income. It makes a difference.
| Yield | Annual Gross Income | Total Portfolio |
| 4.5% | $45,000 | $1,000,000 |
| 4.5% | $54,000 | $1,200,000 |
| 4.5% | $63,000 | $1,400,000 |
| 4.5% | $72,000 | $1,600,000 |
| 4.5% | $81,000 | $1,800,000 |
Ratio Strategy
As a start, ignore the companies and just focus on the math since it’s a math problem to start with.
We break down the ratios by the 4 groups we identified above and start doing math with a $1,400,000 portfolio we can have the below as a safe start.
| Portfolio Ratio |
Amount | Assumed Yield |
Annual Income |
|
| Risky Yield | 5% | $70,000 | 7.0% | $4,900 |
| High Yield | 20% | $280,000 | 5.0% | $14,000 |
| Normal Yield | 60% | $840,000 | 3.5% | $29,400 |
| Low Yield | 15% | $210,000 | 1.5% | $3,150 |
| $1,400,000 | 3.68% | $51,450 |
Not the income you expected I would assume. Let’s tune it to have a 4% total yield without taking risk.
| Portfolio Ratio |
Amount | Assumed Yield |
Annual Income |
|
| Risky Yield | 5% | $70,000 | 7.0% | $4,900 |
| High Yield | 30% | $420,000 | 5.0% | $14,000 |
| Normal Yield | 60% | $840,000 | 3.5% | $29,400 |
| Low Yield | 5% | $70,000 | 1.5% | $3,150 |
| $1,400,000 | 4.03% | $56,350 |
I know what you are thinking, with a portfolio this size, why can’t I generate more? Let’s be a bit more aggressive now and limit growth of capital in favor of income.
| Portfolio Ratio |
Amount | Assumed Yield |
Annual Income |
|
| Risky Yield | 10% | $140,000 | 7.0% | $9,800 |
| High Yield | 45% | $630,000 | 5.0% | $31,500 |
| Normal Yield | 45% | $630,000 | 3.5% | $22,050 |
| Low Yield | 0% | $0 | 1.5% | $0 |
| $1,400,000 | 4.53% | $63,350 |
As you can see, the excercise is still not talking investments. We are simply doing math with assumed numbers. The above table has an aggressive ratio for holdings as there is a risk implied as you move your ratio towards risky yield.
Assuming this portfolio ratio is what we want where normal yield stocks will provide the dividend growth to keep up with inflation, then we are left with increasing the yield for normal and high yield.
| Portfolio Ratio |
Amount | Assumed Yield |
Annual Income |
|
| Risky Yield | 10% | $140,000 | 7.0% | $9,800 |
| High Yield | 45% | $630,000 | 5.5% | $34,650 |
| Normal Yield | 45% | $630,000 | 4.0% | $25,200 |
| Low Yield | 0% | $0 | 1.5% | $0 |
| $1,400,000 | 4.98% | $69,650 |
Are you satisfied with the number now? I feel we reach the optimal ratio with minimal risk to sleep at night. If you push higher, you end up with riskier holdings. This is why my retirement number needs a bigger portfolio.
The above are all hypothetical and the reality will differ but you can use the format to think about your portfolio construction.
Pushing Your Income Higher
Most companies rarely reach the high yield and to reach the risky yield, you will need to look into covered call ETFs, or alternative investments such as Canoe Income Fund.
For example, ZWB is a covered call ETF following the banks and will provide a higher yield than the banks. However, you lose the dividend tax credit, you lose the dividend growth, but you gain an extra 2% to 3% income.
Published at Tue, 19 Apr 2022 05:19:00 -0700
