Investment management strategies to optimize your income asset allocation plan are crucial in the current low interest rate environment. In August of 2011 I put together an example mini portfolio of six dividend paying stocks in my post “Sell Bonds and Buy Best Dividend Paying Stocks?” We will look back and examine how that worked.
The Federal Reserve policy of keeping short term rates near zero is causing investors to move out on the risk curve to obtain income. The result is an environment unlike any we have seen in our lifetimes; requiring investors to rethink their investment management strategies; particularly income asset allocation.
Income Asset Allocation
Retail investors are pouring billions of dollars into bond funds. I fear they have little understanding of the high risk they are taking. The case against bonds is compelling.
Record low yields and record high bond prices make bonds a lower return higher risk asset than we have seen in decades; possibly ever. At times, inflation indexed bonds or TIPS have provided an alternative; but TIPS currently have a negative yield, making them risky too.
Dividend Growth Model
Dividend growth investing can reap the benefits of growing dividends. Through exponential growth and dividend growth compounding investors can achieve competitive returns regardless of whether the price of the common stock increases in value or not. Dividends should be a key component of investment management strategies.
Cash and Cash Equivalents
The returns on cash are so low I use a 0% rate of return assumption. Hopefully, we will return to a more normal interest rate environment where savings is rewarded instead of penalized, but for right now earnings on cash are non-existent.
Low returns do not mean you should abandon the safety and liquidity of cash. Cash provides capital for investment when bargains are available and provides the important function of capital preservation.
Optimize Your Income Asset Allocation Plan
Here is the example mini portfolio I proposed in August of 2011. These 6 dividend paying stocks come from six different industries for diversification; communications, utility, technology, pharmaceutical, energy, and defense & aerospace.
x Price on *Dividend Price Total
Verizon (VZ) $33.12 5.9% $44.60 + 41%
Exelon (EXC) $39.94 5.3% $38.92 + 3%
Intel (INTC) $20.11 4.2% $26.88 + 38%
Eli Lilly (LLY) $34.80 5.6% $38.92 + 17%
Chevron (CVX) $90.25 3.5% $113.55 + 29%
Lockheed(LMT) $68.90 4.4% $91.03 + 37%
Average Total Return +28%
10 Year Treasury Return *2.3% yield
*Yield on original purchase
I recommended “investors who are risk adverse can split their asset allocation evenly between dividend paying stocks and a money market fund”. Even risk adverse investors would have had a 14% gain with only half of their money in equities!
In this low interest rate environment you can use a combination of dividend paying stocks and a healthy amount of cash to avoid risky bonds, collect a growing stream of dividend income, and manage your risk. This is an excellent demonstration of how investment management strategies can optimize your income asset allocation plan and achieve greater income and less risk.