Diversify and Modernize Your Income Sources

Aug 28, 2019

By Pete Biebel, Senior Vice President

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Investors who are entering the autumn of their investing career might want to put a little spring into the income side of their portfolios.  As investors approach their retirement years they typically de-risk their portfolios, shifting out of riskier equity investments and into more stable income-producing assets.  In the olden days, that shift was accomplished by buying bonds.  While investors were able to diversify their bond portfolios by holding a variety of sectors and maturities, they faced a paradox: Any action to increase income would bring increased risk (longer maturity, poorer credit) and any action to decrease risk meant reducing income (shorter maturity, safer credits).

Diversification across maturities is referred to as a bond ladder.  By spreading the bonds’ maturities across a number of different years, investors can reduce the risk that they’ll have a large portion of their portfolio mature at a time when the rates available for the reinvestment of the proceeds are unattractive.  Bond mutual funds and ETFs are available that provide a widely diversified portfolio with even a relatively small investment.

What non-bond alternatives might you consider?  One approach that should not be dismissed too quickly is holding some solid dividend-paying stocks.  With bond yields near historic lows, the relative attractiveness of income producing stocks suggests that they should be considered as part of an income-oriented portfolio.  Your advisors can help to identify a diverse group of stocks with long histories of paying and increasing their dividends.  They can also provide information on dividend-focused exchange-traded products that are similar to dividend-focused mutual funds, but which are typically less likely to be forced to pay out a taxable year-end distribution.

Along that same line, income-oriented investors can also consider holding some exchange-traded REITs and/or MLPs.  Here investors should probably focus more on the quality of the underlying company than the size of the current dividend.

Fortunately, while you were working and saving for retirement, the financial services industry has developed a variety of products that not only could be a good fit for an income-oriented portfolio, but also could increase portfolio income while reducing portfolio volatility.

In recent years, hundreds of mutual funds have been rolled out that focus on “alternative investments.”  Many of these “Alt” funds are dedicated to strategies like “long/short equity,” “managed futures” and “global macro.”  Most of them have produced very disappointing results.  However, included within this family of Alt funds are some mutual funds that concentrate on non-traditional income sources.  Your advisors have access to several funds that specialize in niche markets like seasoned, floating-rate mortgages.  The characteristics to look for are low volatility and low correlation to traditional fixed-income benchmarks.

Talk to your BFE advisor about what steps you can take to increase your portfolio’s income without increasing risk.

Asset allocation/diversification cannot guarantee a profit nor protect against loss in a declining market.Dividends are not guaranteed and are subject to change or elimination. Dividends can be increased, decreased or totally eliminated at any point without notice. Investing in fixed income securities involves certain risks such as market risk if sold prior to maturity and credit risk especially if investing in high yield bonds, which have lower ratings and are subject to greater volatility. All fixed income investments are subject to availability and change in price and may be worth less than original cost upon redemption or maturity. Distinct from traditional fixed income is the alternative income category, which includes high yield debt, emerging markets debt and REITs. Such investments offer greater income potential but also higher levels of risk than traditional forms of debt. There are special risks associated with an investment in real estate, including credit risk, interest rate fluctuations and the impact of varied economic conditions. Distributions from REIT investments are taxed at the owner’s tax bracket.