Retirement Portfolio Construction – The Income Method

Co-produced with Treading Softly and PendragonY

We have been releasing a series of articles explaining, defending and teaching investors the basics of the methodology we use to see success. Today we want to look at another issue and apply how we succeed to teach you more about how the Income Method works.

Everything Needs a Purpose

I remember playing with Legos when I was younger. The brightly coloured plastic blocks provided a means to build anything my young imagination could conceive of.

Lego blocks


Similarly the market offers countless choices of securities in which to invest your hard-earned money, but thoughtlessly or carelessly investing that money could cause you great harm! Having a set goal or purpose behind your choices will ensure success.

The Right Materials are Essential

Even with a set goal, using the proper materials in the effort to achieve your goal is essential. Building a wall, for example, you have countless types of materials that can be used. Building or designing your portfolio to provide for your income can be compared to building a wall around yourself and loved ones to withstand life's storms. Often we have varied choices, just like we do in the markets.


A garden fence might stop small animals and young children from breaching your barrier, but equivalent protection in your portfolio will not withstand storms or strong blows that life might bring, like unexpected medical expenses. Often these simple-to-put-together fences are designed more for show than for practicality. Many investors follow the slogans and banners build portfolios like this fence. Pretty to look at, but otherwise not useful.


A privacy fence would provide greater protection. However it isn't designed to be a barrier for the long haul. This barrier might provide adequate protection in the medium term but over an extended time, it would fail. It would rot and break down.


When building a portfolio, you want it castle strong. You want it to be able to withstand years of abuse and remain standing tall, resilient in the face of adversity.

The goal of any investor should be not to have garden fence or privacy fence portfolios, but rather castle-wall-like portfolios. We also don't want our portfolio to simply protect us from life's storms; we want it to provide an income to live off of or with which to reinvest.

It All Comes Down to Construction

When it comes down to it, the nitty gritty details are key. How you mix the mortar or the ratio of sand and water in concrete is essential. We believe in mixing conservative-yielding names with high-yielding ones to achieve our target yield safely. By pairing off these securities, we create a direct link in their yields and risk to produce a lower overall risk. By further diversifying among at least 40 names across various sectors - like MLPs, REITs, and fixed income to name a few - you are taking the various resources available to you and making the best choices.

An old example given is that two men are building a home. One uses cheap, quick materials - wood, hay, stubble - and the other uses valuable, sturdy ones such as gold, stone, precious gems. When the fire of life is brought to bear, the cheap, quick structure is utterly consumed and destroyed. Investors need to be aware of what they're building their financial future with and how they are building it. Not all securities are made equal.

So how do we build a portfolio that can not only withstand the wildfires of a recession but also provide the high immediate income that investors and retirees need? By pairing securities together. Using this method, individual investors can achieve a twofold goal - high yields and safety.

Pair Securities Together

Oxygen and hydrogen are two elements, and separately they are gasses, but together they create water - something essential to putting out fires but also a unique substance all its own. Mixing carbon with oxygen creates entirely different substances that can be extremely harmful to you. Likewise, mixing securities together to find the correct beneficial mixture is something we do.

A portfolio made up of entirely Oxford Lane Capital (OXLC), yield of 15.6%; Eagle Point Credit (ECC), yield of 13.6%; and XAI Octagon Floating Rate & Alternative Income Term Trust (XFLT), yield of 9.3% would produce extremely high immediate income. But the price volatility would cause most investors ulcers. Meanwhile a portfolio of AT&T (T), yield 6.3%; Dreyfus Municipal Income (DMF), yield 5%; and EPR Properties (EPR), yield 5.7% would be extremely defensive - but it would also lack the income generation most investors and retirees need.

The careful mixing and appropriation of these funds could readily produce a defensive portfolio that produces the income one needs. We aim to generate a 9-10% yield and currently produce a 9.5% yield.

Mixing OXLC's 15.6% yield with EPR's 5.7% in only takes a 50/50 split to achieve a 10.7% yield. That heavily reduces the volatility effect of OXLC while still greatly benefiting from the income from it.

Our Core Portfolio is structured so that mixing lower stable yielding companies mixed with higher yielding securities creates the best of both worlds. Often investors see OXLC or ECC's yield and think, "danger too high!" but they fail to overcome their conditioning to realize the risk vs. reward of holding a small amount of these funds - that this will produce significant income gains with little risk.

To further diversify, HDO holds multiple MLPs like Energy Transfer (ET), yield 8.4%, or Global Partners (GLP), yield 10.2%; multiple REITS like Iron Mountain (IRM), yield 7.8%; high-quality BDCs, like Ares Capital (ARCC), yield 9.4%; and fixed income securities like bonds, preferred stock, and fixed-income CEFs. We are currently recommending a heavy allocation of 40% to fixed income. For this purpose, our Preferred Stock Portfolio alone includes over 50 recommendations with an average yield of 7%.

By staying diverse in recession-resilient sectors and mixing stable, medium-yielding securities with higher-yielding securities, we readily achieve both goals - capital preservation and high immediate income. Our portfolio contains over 40 securities - not including our all-bonds and preferred portfolio, which are suitable if you want a more defensive position with a lower income goal.

This mixing securities at the correct ratio produces phenomenal results, and while the market has taken a beating these last few weeks, our portfolio has seen lower volatility and outperformed the market.

Consider the Benefit or Drawback of Each Choice

When looking to invest in a security in isolation you must verify the quality of its balance sheet, its dividend coverage and its future outlook. If it passes these checks you then evaluate its value versus its price. If overpriced you avoid it, and if underpriced you should consider adding it. But the hardest aspect is knowing how it will fit into your total portfolio.

This is where pairing off securities reduces headaches and makes portfolio management and strategy easier. Consider our OXLC and EPR combo at 50/50. OXLC generates high income but suffers from price volatility, possibly meaning it would be excluded from a conservative portfolio. EPR yields lower than the goal but sees strong price appreciate and higher stability. There are reasons to exclude both individually, but together as a pair, their higher yield and medium volatility mean they can be included. They now provide higher diversification and the ability to broaden the scope of your investments.

Investors, when determining the strategy of their portfolio, need to review the entire scope of their wall before picking the individual bricks used to build it. Bricks alone without mortar will fail to be as strong. This pairing of securities allows you to include otherwise excluded securities to improve a portfolio's overall composition.

Try an additional verification step before you add securities to your watch or buy list. First do your usual due diligence. If a company has only a single reason to not be included - such as EPR's low yield or OXLC higher volatility - consider adding it to a secondary list that requires securities to be pair off together to be included. In fact this is a strategy we use, and it's why we've been able to include a larger range of securities without breaking our portfolio's target yield.

Treat Paired Securities as One Entity

Once paired it is best to evaluate these securities as one entry in your portfolio. They were added as a pair together and need to be evaluated as a unit to ensure your portfolio is stable. That means if OXLC needs to be trimmed, consider trimming EPR to maintain the stability and yield.

This also reduces the perceived number of securities that you oversee. This doesn't change the reality of the number of holdings but it simplifies overseeing and managing them in total.


Investors face a daunting task sorting through various securities to find the right fits for their portfolio. Often investors run to quick and simple solutions that produce poor results and would be readily destroyed in a recession.

Taking your time, doing research and crafting a strong and income-producing portfolio is not easily done. No shortcuts can be taken. Hours of research are necessary. There is no replacement for making the effort to build what will protect you and your loved ones from financial calamity.

Mixing or pairing off securities in your portfolio can help you manage individual risks and rewards and avoid getting lost in the potentially vast size of your portfolio. Aiming to cover one security's weaknesses with the strength of another can improve both within a total portfolio framework.

You can build a fireproof, recession-resistant portfolio alone. I believe in you. Apply the above principles of mixing the right securities to create something spectacular!

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Disclosure: I am/we are long OXLC, ECC, XFLT, GLP, T, ARCC, IRM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.