A sense of security comes from seeing a regular monthly income from your investment portfolio.  Especially when one is retired or is dependent on investment income to meet everyday expenses.

In the investment community, bonds are considered second class citizens.  Investors are told that holding bond funds is done primarily to reduce the overall portfolio risk of owning stock funds. (You never hear it put the other way—stocks are owned to add some spice to your bond portfolio).   At parties, who ever talks about the bond market?

The following are questions I will opine about in future articles:

Is focusing on income different than investing based on asset allocation?

Does an increase in the equity portion of your investment portfolio equate to income from the fixed income portion?

What is the best way to think of stock dividends?

Other than age, when should you be 80 percent or more invested in fixed income securities?

With everyone predicting inflation around the corner, how can you be comfortable with a sizable proportion of your investment portfolio in bonds?

Why don’t more people invest more in bond funds?

What is an appropriate bond fund strategy?

When does investing in a high yield bond fund make sense?  And does this answer change if you substitute the term “junk bond fund”?

Investor inquiry—“I don’t really care about asset allocation; I just want my one million dollar portfolio to produce $4,000 of income every month.”

 

Well, why not construct a portfolio that mimics an annuity, without the costs and fees.  And returns the principal to the investor.  And earns a 5 percent return in today’s interest rate environment.  Can this be done within an acceptable risk profile?

My model portfolio could look like this:

  1. $700,000 in a high yield fund at 6.1% produces $3500 per month.
  2. $200,000 in a total bond market fund at 2.7% produces $450 per month.
  3. $100,000 in a total stock market fund with a 1.3% dividend yield produces $100 per month.

This results in a 90/10 bond/equity mix.  The bond funds each have duration of 5.0.  Most importantly, the investor can depend on a predictable monthly income stream.

Are the risks unacceptable?  Inflation would seem to be the most significant risk with a one percent increase in rates reducing the portfolio by $45,000.  Default risk is always an issue with high yield funds.

But for some investors the tradeoffs might seem acceptable.  I would argue that this is a preferable approach than to purchase an annuity producing this amount of monthly income.  This is primarily because an annuity carries such heavy fees.  I just recently talked with a neighbor who paid a 5 percent upfront fee to purchase an annuity from a well known insurance company.  Seems like a high price to pay.

By Dan Edinger