A 3 fund portfolio for retirement
Whether someone is considering retirement or simply contemplating what financial independence would look like for them, at High Yield Investor we believe that residual income is of paramount importance.
For investors who wish to achieve financial independence and ability withdraw from their investment income when they wish, we have identified a portfolio of three funds that should offer capital preservation, high income and some growth.
Why Really Passive income is so important
There is simply no better and safer way to achieve this consistent financial independence than through recurring income streams that require little maintenance or time investment.
Let’s break this statement down because it contains several important points.
First, why recurring sources of income? Why not invest in some assets that are expected to increase over time and then sell only a portion of the gains to generate income? are retired often recommended to follow the “4% rule”, according to which you put your money into a broad-based index fund like the SPDR S&P 500 (SPY) or a balanced fund of 60% stocks and 40% bonds like the iShares Core Growth Allocation ETF (AOR) and simply withdraw no more than 4% per year.
However, withdrawing 4% works best when the invested money appreciates in value by 4% or more. When this is the case, an investor’s capital stays the same or grows even if they regularly withdraw 4% of it per year.
What Happens When Stocks Go Into a Bear Market Like 2022? And if you’re betting on bonds to offset stock market losses, what happens when? both Stocks and bonds entering a bear market like last year?
In practical terms, this means your annual payout is shrinking by 4%.
Assuming your account value decreases from $1,000,000 to $800,000, your income from the 4% Rule would also decrease from $40,000 to $32,000. Instead, if you continue to withdraw $40,000 even though your portfolio value has fallen to $800,000, you would be withdrawing 5% of the portfolio value, preventing your portfolio from growing back to its previous value.
When the stock market and bond market fall due to high inflation (and rising interest rates), as we are now witnessing, your income from the 4% rule falls even as your personal expenses rise.
Not exactly an ideal situation. Therefore, the 4% rule does not necessarily result in a consistent or reliable source of income.
Second, consider the point about low-maintenance, low-time income streams.
There are certainly many ways to generate income from investing, but few of them are passive in any real sense.
Take investments in rental properties, for example. While this is a wonderful opportunity to generate tax-privileged income for those interested, it is by no means passive. It takes a lot of work preparing units for move-in, vetting tenants, doing regular maintenance, keeping track of paperwork for tax purposes, etc. The more income one wants to make from rental properties, the more it becomes a job itself rather than one investment on the side.
in so many ways TRUE Financial independence comes from recurring revenue that requires little maintenance or time investment.
That’s one of the reasons we at High Yield Investor love high-yield dividend stocks like the ones in our portfolio. Value investors at heart, we love to combine high-yield dividends with the principles of Benjamin Graham and Warren Buffett.
But to make it even simpler and more passive, here is a highly diversified three-fund portfolio consisting of 2 ETFs and 1 CEF that together offer both high yields and a growing dividend income stream.
Schwab US Dividend Equity ETF (SCHD)
SCHD is the unicorn of diversified dividend stock ETFs. Both offer a moderately high initial yield of over 3% And has an impressive track record of double-digit dividend growth. And investors can get access to this 100-stock unicorn ETF for an expense ratio of just 0.06%.
The ETF’s stock-picking methodology begins with a track record of dividend growth: Eligible stocks must have paid dividends for at least 10 consecutive years and have increased their dividends for the past 5 consecutive years.
Next, SCHD weights eligible companies with several quality factors, such as: B. low debt, high return on equity and high cash flow to debt.
Finally, the ETF selects the top 100 eligible stocks based on the highest dividend yields. Hence the dividend yield of 3.4%, based on trailing-12-month dividends.
The ETF’s sector weights are unpredictable and may change over time, but the overall mix tends to be quite defensive. For example, technology, consumer staples, and healthcare together account for 47% of the total portfolio.
Due to the fund’s limitation to certain quality and dividend growth metrics, the portfolio consists primarily of larger companies that will be familiar to many investors. These are typically industry leaders with strong balance sheets and impressive track records of dividend growth.
Additionally, SCHD does not collect shares based on its track record of dividend growth alone, the fund should remain predominantly focused on fast-growing companies. While dividend growth records are backward-looking, the fund’s quality requirements essentially serve as forward-looking metrics that make faster dividend growth more likely in the future.
However, note from the sector weighting list above that SCHD underrates both Energy and Utilities. That’s not unusual. The ETF is typically sparing with names in these sectors. This is where our next two funds come in.
Global X MLP ETF (MLPA)
MLPA is a premier ETF that owns 20 of the largest and strongest midstream oil and gas companies, which happen to be organized as Master Limited Partnerships (“MLPs”). When an investor owns an MLP individually, they are treated as a limited partner and therefore receive a K-1 form for tax purposes. MLPA is structured to avoid the K-1 form and instead report dividend income on the simpler 1099-DIV.
Such specialized and concentrated funds tend to have very high expense ratios, which actually makes MLPA’s 0.45% quite reasonable.
The ETF’s portfolio is led by a 13% stake in Enterprise Products Partners (EPD), one of the best-run MLPs in the midstream space with arguably the strongest balance sheet and greatest overlap of interests between shareholders and management, which itself owns about 1 / 3. of the company.
But the rest of the portfolio is also populated with strong companies that are well positioned to benefit from the post-COVID recovery in oil and gas exploration. Some of our favorites are Energy Transfer (ET) and Plains All American (PAA).
These companies typically derive the majority of their revenue from fixed-fee take-or-pay contracts with their customers. These agreements allow customers to use as much or as little of their pipeline and storage infrastructure as they want and pay a fee to do so. These fees typically include contractual escalations, often based on inflation adjustments.
In some cases, however, midstream companies derive fees from volumetric usage of their infrastructure (which varies based on usage) or commodity prices. As such pipelines Do benefit to some extent from higher oil and gas prices, but are also largely insulated from market fluctuations through their fixed-price contracts.
A particular growth opportunity for these companies is the growing market for gas exports (especially LNG) to other countries in Europe, Asia and Africa. While MLPs are a high-yield way to invest in energy, they also offer some growth.
Reave’s Utility Income Fund (UTG)
The three-fund portfolio is rounded off by the utility-heavy UTG, which is actually a closed-end fund. The manager, Reaves Asset Management, has overseen the fund for nearly two decades since UTG’s inception in February 2004.
The CEF’s portfolio is approximately 60% utility and 40% non-utility. Most of this non-utility segment is made up of telcos or Real Estate Investment Trusts (“REITs”) that own the communications infrastructure.
However, the portfolio also includes other infrastructure companies such as midstream energy stocks and industrial REITs.
UTG is able to generate an 8% return through the judicious use of leverage. The fund is approximately 25% leveraged and this debt carries a variable interest rate. When rates are low, UTG’s leverage acts as a tailwind for performance, but when rates are high, it is a drag.
If and when the Fed cuts rates from their current high levels, UTG should get a massive tailwind. Not to mention the positive impact on utility investments in the form of tax credits from the recently passed Inflation Reduction Act.
A well-rounded range of income funds
If you want a truly passive income, owning a combination of these three funds could be a great way to do it. Together, they yield an average dividend yield of 6.2% while delivering strong total returns.
While SCHD offers strong upside potential and dividend growth, MLPA and UTG offer strong current income. For retirees, this high income can be deducted, and for investors still in the “accumulation” phase of their journey, it can be used to reinvest for an even larger passive income stream in the future.