One of the three original portfolios, this one uses a modest amount of leverage to create space for allocations to more assets which produce dividends (PFF, EDV, VNQ and VPU). Even with all this leverage, it projects to have the same volatility as the Classic 60/40! (and higher returns!!).
This portfolio is inspired by my wife, who keeps promoting the purchase of high-dividend paying stocks and other income-generating assets on the grounds that they mean you can just live on the dividends and never have to sell shares. I respond by pointing out that the research suggests you’d be better off not prioritizing dividends, and simply selling off assets as needed. It’s more tax-efficient this way, better in the long term, and anyway, it's the total return that matters, not the psychological impact of getting money without cutting into the number of shares you hold (for more, see this video on dividends). This is a somewhat controversial topic, so without being too definitive either way, I’ve decided to create a portfolio that could try to generate enough income that you wouldn’t need to sell, while still following Risk Parity principles. To be clear, I’m not fully on board with this portfolio for my own investing, but I did want to test it under the idea that if I did want to pursue a dividend strategy, I would want to understand how it performs first.
To achieve this goal, I basically have used the leveraged stocks and bonds to obtain a higher exposure to those bedrock asset classes without having to devote as much absolute capital to them. This freed up space for investments in income-generating assets like the preferred shares (which are technically equities but act like bonds and pay out higher than usual dividend rates), Utilities, and REITs. The extended duration bonds also produce more in dividends than other types of treasuries, giving me three different income-generating assets to form the core, surrounded by five other assets for diversification. The key question for this portfolio is whether it can provide enough to live on without ever needing to sell shares. From a convenience point of view, this would certainly be nice, but I am curious to see if the overall returns will match other portfolios. In addition, relying on dividends introduces some additional tax considerations if held in standard brokerage accounts.
The key strength with this portfolio is that it might provide enough income over the course of the year that it can meet the 4% rule without needing to sell every quarter. The high expected dividends in quarter 4 might even allow for adding shares into the portfolio. Psychologically at least, this portfolio might be very comforting, and yet it still promises some growth. When comparing it to other portfolios, it scores quite well, finishing in the top half for every category, except for annual return where it is 6th. The comparison with the 60/40 is quite promising, as it has basically the same volatility, but about half the Ulcer Index, all while expecting to return 1.6% more, even without the dividends being included. This is also the first portfolio to use leverage, though the level is modest, just 50%. The leverage, though, clearly doesn’t add risk compared with a 60/40.
I expect steady growth for this portfolio while it delivers solid dividends, and am indeed thinking this may be a good portfolio for me when I reach the drawdown phase. Other portfolios might outshine it during the accumulation phase, as it does not have much allocated to clear sources for capital appreciation. It could easily be modified, however, perhaps by substituting PFF with a growth oriented fund like VUG. You could also add leverage, by devoting some of PFF’s portion towards even more UPRO or TNA.
Here is the Correlation Matrix (Data from 2009, so please take this with a healthy dose of skepticism; credit to Portfolio Visualizer):
And, the Backtest Analysis (Data from 1970; credit to Portfolio Charts):
Note: this backtest is from the original formulation of the RPC Income portfolio, with 15% allocated to VNQ and 0% to Utilities. Portfolio Charts doesn't track Utilities separately, so it's not possible with the tool. If anything, though, the inclusion of utilities would improve the metrics here, so consider the following a pessimistic outlook.
