Diversification Is More Complex Than Just Adding Different Names

In this low-interest-rate environment, Ryan Mumy, the chief investment officer of Capital Investment Advisory Services says, retirees' monthly income from their portfolios has been getting "squeezed" for some time.

"As a result, we see often where they reach for yield to meet income needs," he says. "And this results in them taking on more principal and interest risk than they're actually comfortable with in many instances."

In other words, they are investing in high-yield bonds and master limited partnerships (MLPs). To be sure, we've quoted plenty of investment advisers who have suggested the exact opposite. But Mumy is in the camp that says retirees, in particular, should avoid the direct and not-so-direct traps that come with being isolated on one criteria.

"Don't partner up high-yield and MLPs, for instance, as it looks diversified on paper, but we've seen them trading in the same direction and they can be influenced by the same macro drivers," he says.

So, what does Mumy suggest for income seekers?

"We encourage income investors to ensure the dividends are covered from cash flow and to take a fresh look at investment grade short-duration, as yields have come up a great deal in the past 18 months," he says. "It's a slippery slope trying to build a conservative, income-producing portfolio in this environment, so prudent, non-emotional decision making is critical."

Laddered CDs and Multi-Asset Income Strategy

Lucas Turton, the chief investment officer at Windham Capital Management, says Windham Capital has avoided intermediate- and long-term U.S. bonds in retiree's accounts.

"To generate income, we've combined laddered CDs and a multi-asset income strategy that includes preferred stocks, high-yield debt, floating-rate debt, dividend stocks, global real estate, and bank loans," he says. "The laddered CDs allow us to reinvest at higher yields and reduce portfolio risk. As for the multi-asset income strategy, it's currently yielding 4.6% and has been flat as 10-year rates have risen over the past three years."

Unfortunately, Turton says, the 4% spending rule, or asset draw-down formula, no longer applies. "Retirees need to lower their return expectations," he says. "I look forward to a more normal rate environment. Prior to the zero-interest-rate policy, or ZIRP, T-bill yields consistently beat inflation."

According to Mumy, there's a lot of value in the 2-year U.S. Treasury right now, as that yield has doubled in the past year and might offer a nice complement to other holdings of income investors.

"We could also make a case for starting an allocation to select U.S.-based publicly traded REITs, as many are down in excess of 20% in the past one year, which might be an overshot to the downside," he says. "It's not as simple as just buying different names/investments and calling it 'diversification.' Balancing the cash flow source and macroeconomic factors behind each income investment in a portfolio is critical."