Investors looking to generate income, especially those approaching retirement, may want to consider tweaking their “balanced” portfolios, according to a recent survey by BlackRock. The S&P 500 is surging 17% in 2024, fueling enthusiasm around tech and artificial intelligence (AI) deals. Tech darling Nvidia is up more than 150% this year, accounting for more than 6% of the overall market index. .SPX Mountainous S&P 500 YTD 2024 While these gains may be exciting, investors nearing retirement are taking on a lot of risk by letting their portfolios hinge on the rise of big tech companies. “I think people are missing the fact that taking an income-driven approach can generate very good returns,” said Justin Christoffel, co-head of income investing, multi-asset strategies and solutions at BlackRock. “We talk a lot about saving for retirement, college, and so on, but not enough time is spent on what to do when you retire and no longer have a paycheck,” he added. “When you retire, you face new risks that you didn’t face when you were saving.” As investors move toward retirement, they can try to manage some of those risks by investing in income-generating assets. That could mean moving from a balanced portfolio of 60% stocks and 40% bonds to a model that allocates to dividend stocks, high-yield bonds and other fixed-income assets to boost income, according to BlackRock’s research. The 40/60 approach The asset manager analyzed different combinations of an income-oriented portfolio that combined the MSCI World High Dividend Yield Index, the Bloomberg High Yield Bond Index and the Bloomberg U.S. Aggregate Bond Index over a 25-year period. BlackRock compared the returns of this portfolio (40% allocated to dividend stocks and 60% to bonds) to a traditional 60/40 portfolio. “Diversified mixed-return portfolios generally delivered better returns for similar levels of risk,” the study found. “In other words, the efficient frontier of an income portfolio is higher than the efficient frontier of a traditional portfolio over a 25-year period.” The efficient frontier is a concept in modern portfolio theory. It represents the set of portfolios expected to provide the highest return for a given level of risk. It also shows that at some point, increasing the risk of a portfolio will result in diminishing returns. This concept of diminishing returns is especially important for investors approaching retirement, who tend to maintain a lot of exposure to large-cap stocks. These individuals struggle with sequential risk of returns – the possibility that they will face a sharp market downturn in retirement, forcing them to unwind a portfolio that is declining in value. “Trying to maximize total returns is not necessarily the optimal strategy,” Christoffel said. “If you experience a drawdown, you’re selling units to maintain the cash flow that you need to live off.” Taking an income-focused approach ensures that interest and dividend payments on bonds generate enough cash flow to prevent retirees and those nearing retirement from selling in a down market, he added. It also helps dissuade them from selling out of fear. “Markets tend to go up over time,” Christoffel said. “And if you take an income-focused approach, in a year or two, the market will probably have recovered and you won’t lose money.” Investors looking to take an income-focused approach should work with a financial advisor to restructure their portfolios and dollar-cost average into these assets over time to ensure their allocation reflects their risk profile and goals. Finding Income-Generating Assets With the Federal Reserve widely expected to start cutting interest rates this September, Christoffel’s team concluded that dividend stocks are an “attractive way to get upside.” Investors looking to diversify can try mutual funds or exchange-traded funds. Vanguard Dividend Appreciation ETF (VIG) has a 2024 total return of 15% and an expense ratio of 0.06%. And the iShares Core Dividend ETF (DIVB) has a 2024 total return of about 17% and an expense ratio of 0.05%. Covered call strategies are another way to boost portfolio returns, the team found. A call option gives an investor the right to buy a stock at a specific strike price by the maturity date. In a covered call strategy, you sell a call option on an underlying asset that you already own to another investor. It’s a move that helps generate income from premiums. The catch here is that you have to be ready to exit the stock if the stock spikes and miss out on further gains. Christoffel’s team also likes floating-rate bank loans and high-quality collateralized loan obligations with AAA ratings. “Compared to fixed-rate securities with similar credit quality, such as high-yield bonds, bank loans today have wider spreads and higher yields,” he wrote. Floating-rate instruments may see their yields fall as the Fed cuts interest rates, but compared to other fixed-rate classes, they can still offer attractive returns. Finally, Christoffel’s team likes high-quality fixed income securities, such as cash coupons and short-term investment-grade bonds, that weigh on the portfolio.
How to restructure your 60/40 portfolio for income generation, according to BlackRock
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