5 Vital Tips for Building the Perfect Income Portfolio
Building the perfect income portfolio is an essential consideration for anyone planning for retirement. Without the right mix of assets, though, you could find yourself at the mercy of the market, and your nest egg decimated long before you have a chance to tap into it.
Writing for Real Deal Retirement, Walter Updegrave explains, “Ideally, when building a portfolio, you want to assemble a group of assets that have low or negative correlations with each other. The idea is that by doing so, your portfolio will be able to thrive in a variety of market conditions, as some investments rack up gains that can help offset losses others are suffering. At the very least, your overall portfolio will be less volatile since not all your investments will rise or fall by the same amount at the same time.”
How do you build the perfect income portfolio, though? It’s a little more complicated than you might assume, but the following vital tips will help ensure that you’re able to do just that.
What Exactly Is an Income Portfolio?
Before we get too far, let’s address the question of what an income portfolio is, and how it differs from other options out there.
First, understand that an income portfolio may or may not yield actual cash in your bank account. These portfolios hold both stocks and bonds. Stocks return via stock price appreciation and dividend payouts. Bonds return with coupons.
All three of those are usually reinvested, further growing your wealth, but not actually resulting in a cash income.
Choose the Right Stocks
Stocks, all stocks, come with significant risk. However, there are ways to mitigate some of that risk. The most important is to choose the right options.
You want equities with at least $10 billion in market capitalization, and a PEG ratio of 1.75 or lower. Beta should be less than 1, and yield should be a minimum of 2.8%.
This allows you to take advantage of the growth potential of the stock market without exposing yourself to quite as much risk (note, that does not mean no risk).
How Do You Build an Income Portfolio? Blend Stocks and Bonds
As mentioned, in order to have a stable, non-volatile portfolio, you need the right mixture of stocks and bonds. Stock returns are always going to be volatile, due to the very nature of the market, and the fact that stock price appreciation can hinge on sentiment, rather than anything concrete.
Blending in bonds allows you to offset that volatility. Of course, the return on bonds is low, but it can be predicted accurately at all times (which is why those in the market often call these fixed income assets).
Now, there are several potential ways to add bonds to your portfolio. You could invest in treasury bonds. You could invest in municipal bonds. You could invest in corporate bonds.
Of those three, you can immediately discount government bonds/treasuries. The return is low, and the risk is increasing (for proof, just look at Germany, where treasury return actually sank below 0). That leaves municipal bonds and corporate bonds. Of the two, corporate bonds are the stronger, better performers.
Which Bond Terms?
Once upon a time, the so-called “long bond” was the best option. However, things have changed. Long-term bonds with a 20-year maturity rate do not pay enough in terms of return to make them attractive options.
In fact, you might gain only another 20 basis points during that time, while your money is locked away and unavailable for reinvestment.
So, that leaves you with other bond options – five and ten-year bonds. These offer an excellent, predictable return on your investment and do not come with either the volatility of stocks, the potential for devaluation of government bonds, or the low yield of long-term bonds.
So, you’ll definitely need shorter-term, corporate bonds in your income portfolio.
Build a Bond Ladder
Within your income portfolio, you shouldn’t have just a random assortment of bonds purchased all at one time, or haphazardly over the years. You need structure – a bond ladder provides exactly that. Unsure of what a bond ladder is or why it matters? It’s actually relatively simple.
In essence, a bond ladder is nothing more than a collection of individual bonds (usually 8 to 10 of them) that have maturity dates one year apart. This allows you to plan your income without any questions, and rely on a constant stream of income for the duration of the ladder (up to 10 years depending on the length of your ladder).
There’s also the fact that investing in a bond ladder allows you to avoid having to predict interest rates years down the road, because the maturity dates will be spread out over the yield curve. You can also adjust your investing every year as each bond matures to meet current financial trends.
Have a Sound Distribution Solution
Building an income portfolio is only half of the equation to ensure that you are able to live comfortably in retirement. You also need to pay attention to distribution.
Once you start taking disbursements, the value of your portfolio is going to decrease. So, it’s essential that you have a way to mitigate the impact of those disbursements, while encouraging growth within the portfolio.
Again, bond ladders can provide a predictable, reliable return, and when blended with the right stocks, can offer a balanced solution to your investing needs.
Ultimately, creating an income portfolio offers balance to your investing, and protection for your nest egg. Combining stocks with high-quality corporate bonds (and bond ladders) can help ensure a comfortable, safe retirement.