Over the past couple of weeks, I have written articles discussing asset-allocation models geared toward investors who are entering retirement and have built moderate-to-large nest eggs. The first two articles in this series presented generally conservative and generally moderate asset-allocation models. In this article, I would like to outline two generally aggressive asset allocations for a $1 million portfolio.
As a reminder, when calculating how much annual income you need to generate from your investments in order to avoid drawing down the portfolio’s principal, subtract Social Security, pensions, income from part-time jobs, rents, etc. from the amount of money you need to live. The remaining amount is the amount that needs to be funded by income generated from your investments.
Additionally, when examining the asset allocations described below, please keep in mind that there are countless variations investors could create. Your investment objectives, risk tolerance, and time horizon will help shape your allocation.
Generally Aggressive Asset-Allocation Model
Investment Grade Bonds and CDs – 30% of portfolio ($300,000)
- 15% of the portfolio ($150,000) laddered into individual investment grade corporate bonds and certificates of deposit (CDs) with less than 10 years to maturity.
- 15% of the portfolio ($150,000) laddered into individual investment grade corporate bonds with 10 to 30 years to maturity.
- Position sizes would range from $10,000 to $15,000, depending on your view of the company. This would allow for adequate diversification.
- I would structure the ladder as follows:
- Based on the individual investment grade corporate bonds and CDs trading in the secondary market at the time this article was written, an investor laddering in the manner described above could reasonably expect to generate the following minimum yields and cash each year:
Preferred Stocks and Exchange-Traded Debt – 10% of portfolio ($100,000)
- 10% of the portfolio ($100,000) invested in individual preferred stocks and/or exchange-traded debt.
- Position sizes would range from $10,000 to $15,000, depending on your view of the company. It will not be difficult to obtain an average yield of no less than 6% on this allocation ($6,000 of annual income).
Non-Investment Grade Bonds – 20% of portfolio ($200,000)
- 20% of the portfolio ($200,000) allocated to non-investment grade corporate bonds.
- This money should generally be focused on maturities in the three-to-eight-year range. Whether this is accomplished by purchasing 20 bonds from 20 different issuers or by using non-investment grade bond ETFs is a judgment call. Even in today’s environment, I would expect this allocation to generate no less than $10,000 per year.
Total Cash Flow From Bonds, CDs, Preferred Stocks, and Exchange-Traded Debt:
- $13,050.00 + $6,000 + $10,000 = $29,050.00
*** I intentionally left municipal bonds out of the equation. Munis are best suited for investors with higher incomes. If your taxable income is such that munis make sense for you, they should be built into the investment-grade portion of the total bond allocation.
Stocks – 25% of portfolio ($250,000)
- U.S. indices – 7% ($70,000) – yielding no less than 1.90%. One index fund is sufficient.
- World, ex-U.S. indices – 9% ($90,000) – yielding no less than 2.50%. One or two index funds are sufficient, depending on the fund chosen and the amount of exposure you want to certain parts of the world. For example, the Vanguard FTSE All-World ex-US ETF (VEU) has less than 20% exposure to emerging markets. Investors wanting to increase emerging-markets exposure, while also maintaining exposure to other parts of the world, could own both VEU and the Vanguard FTSE Emerging Markets ETF (VWO).
- Dividend-paying individual stocks – 9% ($90,000) – yielding no less than an average of 2.75%. A $90,000 allocation to dividend-paying individual stocks should be broken into no less than seven stocks.
Total Cash Flow From Stocks (excluding the potential for dividend growth): $6,055.00
- Additionally, assuming a compound annual dividend-growth rate of 5% for the entire allocation to stocks, the $6,055.00 of annual dividends would grow to $9,393.29 of annual dividends by year 10.
Stores of Value – 5% of portfolio ($50,000)
- The world is currently in the midst of a grand monetary experiment, the likes of which has never been seen on a global scale. Nobody knows what the ultimate outcome will be. I think it makes sense to have at least a minimal allocation to the store of value that has outlived fiat currency after fiat currency. Especially for investors with heavy exposure to fixed-income securities, owning a store of value that has stood the test of time is important. I favor gold. Others may prefer a different store of value.
Cash – 10% of portfolio ($100,000)
- “High-Yielding” checking/savings account(s) yielding at least 10 basis points – $100 of interest.
- The yield from a checking/savings account can vary. Should short-term interest rates head higher, it is likely the cash kept in a bank account will generate more income.
- When taking on more risk in a retirement portfolio, investors will want higher levels of cash to offset the possibility of needing liquidity during bear markets and not wanting to sell stocks and/or long duration bonds at depressed prices.
Total Annual Cash From Generally Aggressive Asset-Allocation Model
- $29,050.00 + $6,055.00 + $100 = $35,205.00
- $35,205.00 is the minimum one would expect from this type of allocation at today’s yields.
- The yield on the total portfolio is 3.5205%.
- The yield on the non-cash, non-stores of value portion of the portfolio is 4.13%.
Keep in mind that the asset-allocation model outlined above has the potential for income growth. This would come from dividend growth from the equities allocation, and the potential for reinvesting the laddered bond allocation at higher rates as bonds mature.
Another Generally Aggressive Asset-Allocation Model
The next asset-allocation model to consider is even more aggressive but provides the most income of any of the five allocations outlined in this series of articles. The most aggressive allocation can be created by making the following changes to the model outlined above:
- Shift the $100,000 of investment grade corporate bonds and CDs maturing in years six through nine into 10-year investment grade corporate bonds. This would increase annual income by $1,200.
- Move $50,000 out of investment grade corporate bonds maturing in years 10 through 30, and invest the money in individual preferred stocks. This would increase annual income by $375.
- Eliminate the $70,000 of exposure to U.S. equity indices, and split that money between the two other categories of equities outlined in the asset-allocation model above. This would increase annual income by $507.50.
- Investors making all three changes could increase annual income by $2,082.50, bringing the yearly total to $37,287.50. This would increase the yield on the total portfolio to 3.72875%.
Once you identify the general allocation you want to have for the first day of retirement, you will need to begin choosing the specific securities that will comprise the portfolio. I think it is best to give yourself a couple of years to identify and purchase those securities. By beginning the transition from a non-retirement allocation into a retirement allocation a few years before you will depend on the portfolio, you will likely allow sufficient time to strategically enter positions at more favorable prices. The challenge, of course, will be to identify securities that are trading at attractive levels.
*The asset-allocation models described in this article are impersonal. The asset-allocation models described in this article should not be viewed as investment advice. Only you can decide the allocations and securities that are appropriate for your portfolio.
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