Investors with an eye on income generation – especially as they look toward retirement – may want to consider improving their “balanced” portfolios, according to recent research from BlackRock. The S&P 500 is up 17% in 2024, buoyed by bullishness around AI technology and trading. Tech-darling Nvidia, up more than 150% this year, accounts for more than 6% of the broad market index’s weighting. .SPX YTD mountain S & P 500 in 2024 As exciting as these gains are, investors nearing retirement are courting plenty of risk by letting big tech drive their portfolios. “I think people lose sight of the fact that you can generate really good returns from an income-oriented approach,” said Justin Christofel, co-head of income investing, multi-asset strategies and solutions at BlackRock. “We talk about saving for retirement, saving for college and saving for a lot of things — but there’s not enough time for what to do when you retire and you’re no longer earning a salary,” he added. “When you retire, you face new risks that you didn’t face when you were saving.” Investors can try to manage some of that risk heading into retirement by getting into income-producing assets: That could mean moving from a balanced portfolio that’s 60 percent in stocks and 40 percent in bonds to a model that combines income with dividend distributions – paying stocks, higher-yielding bonds and other fixed-income assets, BlackRock found. 40/60 Approach The asset manager analyzed different combinations of an income-focused portfolio – combining the MSCI World High Dividend Index, the Bloomberg High Yield Bond Index and the Bloomberg US Aggregate Bond Index – over a 25-year period. BlackRock then compared the returns of this portfolio – which included a 40% allocation to dividend-paying stocks and a 60% allocation to fixed income – with a traditional 60/40 portfolio. “Diversified mixed income portfolios … have generally delivered better returns for similar levels of risk across the spectrum,” the study found. “In other words, the income portfolio efficiency frontier is higher than the traditional portfolio efficiency frontier over the 25-year period.” The efficient frontier is a concept in modern portfolio theory: It depicts a set of portfolios expected to offer the highest return for a given level of risk. It also shows that at some point, increasing portfolio risk will result in decreasing returns. This concept of diminishing returns is especially important for investors nearing retirement who may tend to remain heavily exposed to large-cap stocks. These individuals face yield series risk – that is, the possibility of facing a sharp market decline as they retire and being forced to withdraw a portfolio that is declining in value. “Trying to maximize total return is not necessarily the optimal strategy,” Christofel said. “If you experience a pullback, you sell units to maintain the cash flow you’re living off of.” By taking an income-oriented approach, bond interest and dividend payments can generate enough cash flow to keep retirees and near-retirees from selling in a bear market, he added. It can also prevent them from selling out of fear. “Markets are trending higher over time,” Christofel said. “And you’re not worse off a year or two later with that income approach because obviously the markets have recovered.” Investors aiming for an income-focused approach should work with their financial advisor to adjust their portfolios so that they can dollar cost average these assets over time and ensure that their allocation reflects their risk profile and objectives. Finding income-producing assets With the Federal Reserve widely expected to begin cutting interest rates this September, dividend-paying stocks are “an attractive way to play upside,” Christofel’s team found. Investors looking to take a diversified approach may want to try a mutual fund or ETF. Vanguard’s Dividend Appreciation ETF (VIG) has a total return of 15% through 2024 and an expense ratio of 0.06%. There’s also the iShares Core Dividend ETF (DIVB), with a total return of around 17% through 2024 and an expense ratio of 0.05%. Covered call strategies are another way to boost portfolio income, according to the team. Call options give an investor the right to buy a stock at a given strike price before an expiration date. A covered call strategy involves selling another investor a call option against an underlying security you already own – a move that can help generate premium income. The catch here is that you have to be prepared to part with the stock and lose additional upside if its value skyrockets. Christofel’s team also likes floating rate bank loans and AAA-rated high-quality collateralized debt obligations. “Compared to fixed-rate securities of similar credit quality such as high-yield bonds, bank loans today offer wider spreads and higher yields,” he wrote. Although floating-rate instruments could see their returns decline as the Fed lowers interest rates, these offerings may still offer attractive returns compared to other fixed-income classes. Finally, Christofel’s team likes high-quality bonds to provide ballast in a portfolio, including cash coupons and short-term investment-grade bonds.
