Attractive bond yields have been a boon for investors, such as retirees, who want to generate income from their portfolios. Yet, those who want to live off the income generated by their investments — without selling any stocks — may want to reconsider how their portfolio is set up. An efficient portfolio typically focuses on both income and price returns, said certified financial planner David Blanchett, head of retirement research at PGIM, the asset management arm of insurer Prudential Financial. “If I’m someone who’s focused on not accessing capital or principal and want to live off income, that really can lead to different perspectives on efficient portfolios,” he said. While being heavily weighted in stocks may make sense when dividend yields are higher than Treasury yields, like in 2020, the opposite is true now for those focused solely on income generation. With bond yields exceeding dividend yields by about 300 basis points, those investors could have an equity allocation likely below 10%, according to Blanchett’s calculations. The S & P 500 currently has a 1.5% dividend yield, while the 10-year Treasury yields 4.25%. US10Y 1Y mountain US 10 Year Treasury Yield over the past year “A question really is: What is my comfort level when it comes to spending down the portfolio?'” Blanchett said. If you aren’t comfortable, that’s where income generation can be really valuable, he added. “It really depends on that retirees’ perception of how they’re going to access their savings to fund their retirement spending,” Blanchett said. Higher yields are doing the heavy lifting Generally, the rule of thumb is to withdraw about 4% of your portfolio a year during retirement. Back when bonds were yielding 1% or 2%, stocks needed to return 10% or more for investors to maintain their balanced portfolio, said CFP Barry Glassman , founder and president of Glassman Wealth Services in North Bethesda, Maryland. “What has changed with higher rates is that retirees no longer need to depend so much on stocks to do well for them to achieve a successful retirement,” said Glassman, a member of the CNBC Financial Advisor Council . “It is absolutely time to consider what balance is appropriate over the next few years.” Still, it’s important to understand just how much money you’ll need in retirement, and if you will have a pension to supplement your income. Glassman suggests reviewing your monetary needs for each year and figuring out what your portfolio can provide without you having to sell anything. He likes actively managed diversified bond funds for fixed income. They will own Treasurys and corporate bonds and have varying duration, Glassman said. His firm uses the Dodge & Cox Income (DODIX) fund and BlackRock Strategic Income Opportunities (BSIIX) fund. Meanwhile, if you are not as focused on purely generating income, a good rule of thumb for your mix of fixed income and equities is to use your age as a guide, said Brandon Goldstein, a financial planner with Prudential. For instance, if you are 60 years old, have about 60% of your portfolio in bonds, he said. If you prefer buying individual bonds over funds, he suggests laddering bonds with staggered maturities based on how long you think you’ll need the income. “For you to put together a truly diversified strategy where you’re getting different yields, different durations, you need a lot more capital to invest at the beginning,” Goldstein said. However, bond funds give you diversification, he noted. The case for equities Even those who want to focus on income generation may still see benefits from equities, especially if they are in a taxable account, Blanchett said. That’s because qualified dividends are subject to capital gains tax treatment, which is as high as 20%, while interest from bonds is taxed as ordinary income at a top rate of 37%. “There still is a case for especially high tax investors owning megacap equities that have higher yields to take advantage of that have more favorable tax status,” he said. Also, coupons are effectively a set rate, while companies can grow dividends over the long term, Blanchett said. “If you have a diversified portfolio, in theory, you can actually get higher income over time as the companies that you own pay out higher dividends,” he said. “That’s actually why owning dividend-earning equities is more favorable when yields are similar because there’s a potential for appreciation in the income you received from stocks over the long term.”
