Two Moderately-Aggressive Asset Allocations For Income-Focused Investors

asset allocation

etfs-asset-allocationIn last week’s article, “A Conservative Asset Allocation For Income-Focused Investors,” I noted that the process of managing cash flows starts with the following calculations:

1. Calculate the annual amount of money you need to live.
2. Subtract Social Security, pensions, part-time jobs, rental income, and other non-financial-markets-related income from the amount of money you need to live.
3. The remaining amount is the amount that needs to be funded by income generated from your investments.

Furthermore, I offered a generally more conservative asset-allocation model for a $1 million portfolio that included bonds, CDs, preferred stocks, exchange-traded debt, gold, common stocks (individual equities and index funds), and cash. Using today’s yields as a guide, the overall yield for the generally-conservative allocation was 2.968%. Even though 2.968% is not a bad yield considering the conservative nature of the portfolio and today’s historically low interest-rate environment, some investors will need to take on more risk in order to fund step three (above).

Additionally, some investors may want to take on more risk in order to generate enough income that some of it can be saved and invested. Continuing to save and invest in retirement is not a luxury everyone will have. But for those that can, it will help to increase their annual income, providing some inflation protection in retirement.

As a reminder, this series of asset-allocation articles is geared toward investors who have built moderate-to-large nest eggs and are looking for general ideas about how to allocate their investments.

Asset Allocation Examples

What follows are two examples of asset allocations investors with moderate risk tolerances and $1 million in retirement savings could consider. Naturally, there are countless variations investors could create, and your investment objectives, risk tolerance, and time horizon will help shape your allocation.

Generally Moderate Asset-Allocation Model

Investment Grade Bonds and CDs – 40% of portfolio ($400,000)

  • 30% of the portfolio ($300,000) laddered into individual investment grade corporate bonds and certificates of deposit (CDs) with less than 10 years to maturity.
  • 10% of the portfolio ($100,000) laddered into individual investment grade corporate bonds with 10 to 30 years to maturity.
  • Position sizes would range from $10,000 to $20,000, depending on your view of the company. This would allow for adequate diversification.

I would structure the ladder as follows:

Screen shot 2013-11-25 at 9.46.27 AM

  • 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:

Screen shot 2013-11-25 at 9.46.34 AM

  • Investors likely won’t generate “real” yields from all the rungs. But keep in mind that the purpose of laddering is to ensure that if inflation and yields tick up, you have funds maturing in the near future that can be rolled into higher-yielding securities.

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 – 15% of portfolio ($150,000)

  • 15% of the portfolio ($150,000) 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 15 bonds from 15 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 $7,500 per year.

Total Cash Flow From Bonds, CDs, Preferred Stocks, and Exchange-Traded Debt:

$15,112.50 + $6,000 + $7,500 = $28,612.50

*** 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 – 20% of portfolio ($200,000)

  • U.S. indices – 5% ($50,000) – yielding no less than 1.90%. One index fund is sufficient.
  • World, ex-U.S. indices – 7.5% ($75,000) – yielding no less than 2.5%. 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 – 7.5% ($75,000) – yielding no less than an average of 2.75%. A $75,000 allocation to individual dividend-paying stocks should be broken into no less than six stocks.

Total Cash Flow From Stocks (excluding the potential for dividend growth): $4,887.50

  • Additionally, assuming a compound annual dividend-growth rate of 5% for the entire allocation to stocks, the $4,887.50 of annual dividends would grow to $7,582.12 of annual dividends by year 10.

Screen shot 2013-11-25 at 9.46.42 AM
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 corporate bonds at depressed prices.

Total Annual Cash From Generally Moderate Asset-Allocation Model

$28,612.50 + $4,887.50 + $100 = $33,600.00

  • $33,600.00 is the minimum one would expect from this type of allocation at today’s yields.
  • The yield on the total portfolio is 3.36%.
  • The yield on the non-cash, non-stores of value portion of the portfolio is 3.94%.

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 Moderate Asset-Allocation Model

For the second generally moderate asset-allocation model, there are three changes I think investors could consider (change any or all of them).

  • Shift $50,000 of cash into 12-to-15-month CDs. By doing so, investors can reasonably expect to earn a yield of 45 basis points. If investors are able to find “high-yielding” bank accounts at 45 basis points or better, this change would not be necessary. For the purpose of the model outlined above, shifting $50,000 into CDs yielding, on average, 45 basis points, would increase annual income by $175 (0.45% – 0.10% = 0.35% * $50,000 = $175).
  • Eliminate the allocation to four-, five-, and six-year investment grade corporate bonds and CDs. Move that $75,000 into stocks, putting $25,000 in each of the three equity categories outlined above. This would increase annual income by $350 and increase the potential for future income growth from dividends.
  • Shift $50,000 out of non-investment grade corporate bonds into longer-duration investment grade corporate bonds. This change is dependent on the specific yields at which the securities were acquired. If the allocation to non-investment grade corporate bonds ends up with a much higher yield than the 5% assumed above, this change might not be helpful. Using the conservative yields outlined in the model, shifting $50,000 out of non-investment grade bonds into longer-duration investment grade bonds would increase annual income by $125.
  • Investors making all three changes could increase annual income by $650, bringing the yearly total to $34,250. This would increase the yield on the total portfolio to 3.425%.


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 your 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.

Next week, I will explore two additional asset allocations that can be categorized as generally more aggressive.

*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.

More from The Financial Lexicon:
The 5 Fundamentals of Building a Retirement Portfolio
Options Strategies Every Investor Should Know

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