as opposed to someone who wants a completely diversified portfolio.
There is no one “right” allocation. The first step in asset allocation is deciding on your risk tolerance. If you are extremely low-risk, then that portfolio is going to be very different even from the average investor.
What I’m providing here is a suggested asset allocation for those who are geared more toward income and average risk. Those with higher risk tolerance can obviously increase the weighting of pure equities while those of lower risk tolerance can decrease it.
Start With Stocks
The first place to start is with equities. Even if you are an income investor, you have to have stocks, because they are going to provide you with some capital gains over time, as the stock market has a long-term upward bias.
I would start with a 15% weighting in large-cap dividend stocks. This would include either an ETF like Vanguard High Dividend Yield ETF (NYSEArca: VYM) or some of the stocks that the fund holds. This gives you exposure to solid brand-name companies with dividends generally paying 3% or more.
Some conservative investors think international stocks should be avoided, but I totally disagree. International stocks are undervalued compared to domestic stocks right now, and there are numerous outstanding international companies that pay very generous dividends. The iShares International Select Dividend (NYSEArca: IDV) yields 4.5%, and contains several big and familiar names in energy, financial services and pharmaceuticals. I would put 15% in here.
Because of the risk associated with mid-cap and small-cap stocks, I would advise the income investor to only go with companies that they are specifically familiar with. Stocks in these asset classes don’t pay dividends quite as much.
Real Estate Always Comes Back
Next, I would allocate 15% into REITs. The great thing about real estate is that, even if times get really hard such as they did in the financial crisis, real estate will always come back over time.
REITs are required to pay 90% of net income as dividends. Personally, I would diversify across many different kinds of REITs, which you can do using iShares Cohen & Steers REIT ETF (NYSEArca: ICF).
Why I Prefer Preferred Stock
I am a huge fan of preferred stock. These stock-bond hybrids move very little as far as price goes, and they pay extremely generous dividends. You can find many solid plays here paying 7% or more, or you could just grab an ETF like iShares US Preferred Stock (NYSEArca: PFF) which yields 6%. I would drop 15% in here.
Next, I would load up 15% on utilities. The great thing about utilities is that they are regulated. Thus, most utilities draw down debt to fund their infrastructure and expansion, and then can rely on recurring revenue streams from energy usage. Rates usually are raised on a regular basis. The SPDR Select Sector Utilities ETF (NYSEArca: XLU) pays 3.57%.
Finally, a newer security in the market is exchange-traded debt. This is just like holding a bond in a company, but the debt is a bit more liquid because it can be traded on the market like a stock. Although it rests one level below bonds in the capital stack, it rests higher than preferred stock. There aren’t any ETFs for this yet, but plenty of options to choose from. Put another 15% here.
You’ll notice I haven’t suggested bonds. That’s because they pay so little and competing securities pay so much more with little additional risk. Still, you want to have some kind of exposure, so put the final 10% in an ETF of your choice that offers the kind of yield you are seeking.
This article is brought to you courtesy of Lawrence Meyers from Wyatt Investment Research.