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A Simple Portfolio for a 4% Yield
By JLP | December 20, 2007
The January 2008 issue of Money featured an interesting article by Michael Sivy titled The 4% Solution, which is about finding yield for a retirement portfolio. The article mentioned a simple portfolio that currently yields a little over 4%. As Michael mentions in his article, the reason 4% is so important is that most retirees are advised to limit their annual income from their portfolio to 4%. If a retiree can get that 4% in the form of yield, they shouldn’t have to eat into their principal.
The Simple 4% Portfolio
To construct the above graphic, I used today’s prices for the current price and the distributions from the past 12 months for calculating the current yield.
It’s important to note that this portfolio is not without risks. For instance, 10% of the portfolio is invested in financial preferred stocks using the PowerShares Financial Preferred Portfolio (PGF). Although preferred stocks are safer than regular stocks, they are still subject to market declines. Another 10% is invested in high-yield bonds via Vanguard’s High-Yield Corporate Fund Investor Shares (VWEHX). Corporate bonds typically carry more risk than government bonds. The remaining 80% of the portfolio is invested in the SPDR S&P Dividend ETF (SDY), which tracks the S&P High Yield Dividend Aristocrats index.
I did a small amount of research and found out that the PowerShares Financial Preferred Portfolio holds 28 preferred stocks, the Vanguard High-Yield Corporate Fund holds 240 bonds, and the SPDR S&P Dividend ETF holds 50 stocks. This leads to the question: Is there enough diversification there?
Personally, I think I would prefer a more diversified portfolio. More on that later.
Topics: Investing, Retirement Planning | 13 Comments »
December 20th, 2007 at 2:49 pm
That portfolio strikes me as somewhat US centric. Also, what are the good reasons for the money being income based? How about just liquidating for capital gains once in a while and taking the 4% out that way. There are many ways to do this.
December 20th, 2007 at 2:56 pm
Umm maybe I’m missing something here but I come up with a 2.396% yield and not a 4.28% yield. I don’t see how you can add up the yields – you need to do a weight average.
Otherwise you could allocate 1% into 100 different stocks/funds that yield 3% and end up with a 300% yield.
December 20th, 2007 at 2:57 pm
Ignore last post – looking at wrong column for yield
December 20th, 2007 at 3:00 pm
Ignore last post – looking at wrong column.
December 20th, 2007 at 5:51 pm
The other problem is the S&P Dividend ETF is very heavy in financials (36%) and utilities (22%). This isn’t really a well diversified holding, and I would be nervous about having such a large percentage of my portfolio in financial stocks.
I also don’t like the high yield selection because spreads are still very low relative to Treasuries. This is a risky bet, especially for retirees.
I don’t have a problem with the Powershares preferred other than it is a bit costly for my liking. At 72bps, you could probably do better buying a couple preferreds directly.
December 20th, 2007 at 7:08 pm
I don’t understand why some financial advisors suggests that you should take on zero risk at all in retirement. By spending 4% of your net a year and earning 4%, your money is doing nothing to grow for your children and grand children when they inherit it. You can easily invest in quality real estate and conservative mutual funds, get all of your money back and get a much better rate than 4% without taking on all that much risk.
December 20th, 2007 at 7:33 pm
Vanguard Wellesley (VWINX) yields over 4%. It’s ~40% stock and 60% bonds.
Another option might be VG’s Retirement Income (VTINX) which yields around 3.6%. It’s about 30% stock and 70% bonds including TIPS. Add a few percent in equity from some of WisdomTree’s High Yield funds and some more investment grade bonds and you should hit 4% yield.
December 21st, 2007 at 8:17 am
I think the bigger problem with attempting this is that inflation is going to screw you. If you take out all of your yield, you are losing every year because inflation is devaluing the money. You are on a fixed income that is going to feel smaller and smaller every year, because unlike SS (the fixed income we usually think about) there is no COLA.
At least with a reasonable portfolio, you can expect to keep making progress for some time into retirement before your withdrawals overtake your earnings.
December 21st, 2007 at 8:19 am
Never mind. I didn’t read close enough.
Mark me down as agreeing with the “not diversified enough” comments.
December 21st, 2007 at 9:43 am
[...] JLP wrote about a good artcile from one of my favorite investment writers – Michael Sivy. It talks about building a simple portfolio for achieving a 4% yield, taking into account withdrawals that a retired individual will want to do during retirement. [...]
December 21st, 2007 at 10:46 am
Inflation is not an issue. The value of the SDY ETF will go up or down with the rest of the market. Also, most stocks that issue dividends, increase them over time.
December 21st, 2007 at 9:15 pm
It shouldn’t matter whether you use dividends or sales of shares for your 4% drawdown but I know some people have an aversion to selling shares and feel better with just dividends so it’s an idea core for them. I don’t know about randomly throwing in 10% PGF and 10% VEHX. 10% REITs or 10% MLPs or 10% emerging market bonds or whatever might have produce the same mathematical result of 4% overall but they all feel like arbitrary decisions. You could build a more diversified portfolio by holding more high dividend asset classes like so:
SDY – Domestic Large Dividend
DES – Domestic Small Dividend
IDV – International Large Dividend
DLS – International Small Dividend
DEM – Emerging Market Large Dividend
DGS – Emerging Market Small Dividend
VNQ – Domestic REIT
DRW – International REIT
All of the above are in the 3%-6% dividend range and adding 10% of each would get you close to the 4% mark.That leaves 20% for bonds for a bit of stock downturn protection — something like BND at 4.68% (versus high yield which would drop with stocks).
December 27th, 2007 at 8:22 am
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