Creating A Portfolio For Safe Retirement Income
Summary I searched through all ETFs and found six for safe income given the current environment. The portfolio I created generates safe income and has the potential for increasing income if interest rates rise. The six ETFs I found cover: U.S. Equities, International Equities, Bonds, Preferred Stocks and Cash. In this article, I will be creating a simple portfolio that balances steady income with safety for a retirement portfolio. The goal of the portfolio is to hold six ETFs to generate safe income with the potential for income to increase. U.S Equity: ProShares S&P 500 Dividend Aristocrats ETF (NYSEARCA: NOBL ) I chose NOBL because it only holds stocks from the S&P 500 (NYSEARCA: SPY ) that have increased their dividend for at least 25 consecutive years. In addition, what makes NOBL different from other dividend ETFs is that the fund equally weights its holdings, which reduces concentration risk. The chart below from the NOBL fact sheet shows that the dividend aristocrats index that NOBL tracks has outperformed the S&P 500 and done so with lower volatility. [Chart from NOBL fact sheet] International Equity: PowerShares S&P International Developed Low Volatility Portfolio ETF (NYSEARCA: IDLV ) I chose IDLV because it holds mainly large cap companies in other developed markets excluding the United States and overlays a low volatility strategy to select only the stocks with the lowest volatility. The following chart from ETFreplay shows that IDLV has underperformed the largest developed markets ETF, which is the iShares MSCI EAFE ETF (NYSEARCA: EFA ). However, as you can see IDLV has had much lower volatility than EFA and when volatility is factored in IDLV outperforms, which is shown in the table below. IDLV EFA Total Return 29.70% 35.50% Volatility 12.20% 15.20% Return/Volatility 2.43 2.34 [Chart from ETFreplay] (click to enlarge) Short-Term Corporate Bonds: Vanguard Short-Term Corporate Bond Index ETF (NASDAQ: VCSH ) I chose VCSH because the yields for investment grade corporate bonds are higher than corresponding yields on treasury bonds. I did not want to choose just any corporate bond fund; therefore, I decided to select a short-term fund because of the possibility of rising interest rates. The following chart shows a comparison between VCSH, the Vanguard Intermediate-Term Corporate Bond Index ETF (NASDAQ: VCIT ) and the Vanguard Long-Term Corporate Bond Index ETF (NASDAQ: VCLT ). The period I looked at was from February 2nd 2015, which was the low point in interest rates for the year, to June 10th, 2015, which was the high point in rates for the year. As expected VCLT performed the worst because it holds only long-dated corporate bond and VCSH performed the best because it holds only short-term bonds. (click to enlarge) [Chart from Google Finance] Floating Rate Preferred: PowerShares Variable Rate Preferred Portfolio ETF (NYSEARCA: VRP ) I chose to include VRP because of its 5% dividend yield and the fact that it has income upside potential during a rising rate environment. Like VCSH above, I compared VRP and PFF to each other during the rising rate period I described above. As you can see VRP outperformed PFF by just over 1%, which is not a large amount. PFF pays a dividend yield of 5.78%, which is higher than VRP at 5%, however, the 0.78% difference in yield does not make up entirely for the 1%+ in outperformance from VRP. With the upside potential in income during a rising rate environment, I expect VRP to be the superior choice. (click to enlarge) [Chart from Yahoo Finance] Covered Call ETF: Horizons S&P 500 Covered Call ETF (NYSEARCA: HSPX ) As part of my U.S. equity allocation, I chose to include HSPX to increase the income of the portfolio while maintaining income safety. I chose HSPX over the more popular PowerShares S&P 500 BuyWrite Portfolio ETF (NYSEARCA: PBP ) because HSPX pays a monthly dividend where PBP pays a quarterly dividend. HSPX writes out-of-the-money calls on the long positions it holds of all option eligible stocks within the S&P 500. The covered calls, along with dividend income received from individual stocks, makes the current yield based on the average dividend over the last twelve months to be 4.3%. In a declining market, covered call strategies are attractive because of the potential to capture all of the premiums from selling the calls. Cash: PIMCO Enhanced Short Maturity Strategy ETF (NYSEARCA: MINT ) My final selection was MINT because, for retirees, having cash or a cash substitute for an emergency or well-timed purchase of an income generating investment that is trading at depressed values is something to consider. For example, if a retired investor was holding cash during the financial crisis and an opportunity like the bottom of the financial crisis presented itself as a buying opportunity to dividend aristocrats that had been unjustly sold down with the rest of the market. The retired investor having cash available, would have been able to increase their income by buying an ETF with high quality companies at depressed prices. Those high-quality companies have been through ups and downs and still have paid increasing dividends for at least 25 straight years. Portfolio Overview I have provided an example of what the portfolio would look like if each category would be equally weighted. Since NOBL and HSPX both are U.S. equity funds, I split the 20% allocation between the two. Using this allocation, the portfolio yield would be 2.81%, which is not a lot, however it is higher than the rate on treasury bonds. The portfolio has the potential for increasing income in the form of increasing dividend payments from dividend aristocrats and from increasing coupon payments on short-term bonds and variable-rate preferred stocks. Weight Yield W*Y NOBL 10.00% 1.90% 0.19% IDLV 20.00% 3.11% 0.62% VCSH 20.00% 1.92% 0.38% VRP 20.00% 5.00% 1.00% HSPX 10.00% 4.30% 0.43% MINT 20.00% 0.94% 0.19% Portfolio Yield 2.81% Portfolio Composition Stocks 40.00% Bonds 20.00% Other 20.00% “Cash” 20.00% Closing Thoughts While the portfolio I created does not have a large yield, it has exposure to high quality U.S. companies with long a long history of dividend increases, international stocks with low volatility and short-term investment grade corporate bonds and variable rate preferred stocks, both of which should provide safety and increasing income during a rising rate environment. Looking back to my goal, I believe I have created a portfolio that generates safe income and has the potential for increasing income. Disclaimer : See here .