Ultimate Guide To Building A High Yield Dividend Portfolio

Whoa…! Several months ago, I sent an email to the readers asking 2 simple questions:

-Would you be interested in a post about building a high yield portfolio?
-If so, what are some stocks or other assets that you’d possibly include?

By the way, if you’re not on the list, what are you waiting for? It’s free:)

I ended up being completely overwhelmed. I received hundreds of answers. All of you were extremely interested and had tons of suggestions. I started looking at the ideas, at all of these stocks and replied to almost everyone as well. I had initially expected to publish that post a couple of weeks later but ended up doing research for several months (on and off) and feeling like I’d never be able to publish anything. But here I am, ready to go ahead. A few disclaimers:

-There is no perfect portfolio, especially not a universal one. Each one of you would probably aim for something slightly different that would depend on your personal profile (risk appetite, age, means, etc).
-This is a starting point and I plan on updating it over time, and appreciate any feedback, ideas, etc.
-This portfolio is built with $USD stocks as I’ll explain later (most visitors here are US based)

Also, while this is an in-depth article, we have even more info on our membership website, DividendStocksRock (yyyy), be sure to check it out if you haven’t done so yet!

Why A High Yield Dividend Portfolio?

High yield investments are “in” more than ever before. Why? Partially it’s because dividend investing is a proven method to generate good returns but also because in this era of very low interest rates, the traditional retirement investment doesn’t work so well. If you were planning on investing in stocks over your working years and eventually moving to a fixed income portfolio only in order to live off of it, I’ve got some bad news. You’ll need millions in order to survive off of 1% interest rates.

So yes, dividend stocks are very popular not only by individuals but also by pension funds, institutional investors, etc. The problem is that typical blue chip dividend stocks pay a very low dividend yield making it a challenge for most to generate significant income. So several investors have moved towards a higher yield portfolio. The main challenge of course is having limited risk in such a portfolio. There is a reason why some stocks offer higher dividend yields. I’ve mentioned FTR on this portfolio and I can tell you that even with a 10% or so dividend yield, it would never make my portfolio.

Main Objectives For My High Yield Portfolio

I’m looking to build a portfolio that will:

-generate around 5% dividend yield
-have relatively stable income from year to year
-will generate decent total returns (yes income/yield is important but capital preservation is also critical)
-will be highly diversified (in terms of sectors, asset classes, geographic exposure, etc)
-hold sustainable companies (I’m not interested in holding a stock that is hanging on for its life, no matter what the yield is. Distressed stocks is an interesting investing method but I wouldn’t base my retirement on it)
-limit the time required to maintain the portfolio (both in looking for stocks but also in managing taxes, international stocks, etc)

Main Asset Classes

Domestic Stocks: Straight forward right? These are stocks trading on most stock exchanges. I’m personally going to stay away from penny stocks because they are too risky, pink sheet stocks because I’d like to have confidence in the financial filings being consistent, etc.

International Stocks: Ignoring international stocks would be a big mistake. The world is more correlated than it was 20 years ago but those stocks do still provide great opportunities, add diversification to the portfolio, etc.

Fixed Income (government and corporate both domestic and abroad): This is obviously a must as these assets will generally react very differently from others when markets decline providing critical diversification.

Other Fixed Income (bank loans, mortgages, etc): As you can imagine, most of us would not invest in these directly but their is significant income in these products

REIT’s (real estate income trusts): No brainer here, real estate can be a very significant part of any income portfolio and if you’re not considering buying physical buildings, considering REIT’s is a must as they provide high levels of income at historically low risk

MLP’s (Master Limited Partnerships): These more complex instruments that I’ve discussed provide extremely interesting levels of income from energy companies that are able to pass off their income but they do come with rather complex tax implications.

Annuities: These financial products can range from very simple to incredibly complex but the general concept is paying a lump sum in exchange for income that will be paid as long as the buyer is alive.

BDC’s (Business Development Companies): These companies operate in a similar way to venture funds

Preferred Shares: These assets provide a good mix between fixed income and stocks and have provided great income in recent years

Selling Options: The most popular strategy here would be selling call options on stocks that are held (covered calls) which can add to the income but limit the upside (in terms of capital appreciation)

Whole Life Policies: Some of these policies do pay dividends/income

CEF’s (Closed End Funds): Ah, these funds are very difficult to judge as a whole because there are good and bad ones but some certainly provide interesting opportunities

Am I missing anything here?

What I’ll Stay Away From For Now

Annuities: I don’t think I’d consider buying an annuity at this point because I do consider that these investments will provide a higher income at a much lower cost, that is really the whole point of building this portfolio.

BDC’s: I will continue to do research on these but at this point I’m simply not comfortable enough

Selling Options: I’m sure some of you would argue with me on this but I personally think the cost (in terms of bid-ask spread, commissions) and time involved in selling calls. Also, to execute this strategy, a lot more is involved and I can’t imagine trading options without carefully looking at the implied volatility, etc. So not for me, at this point.

Whole Life Policies: Certain whole life insurance policies do pay out cash but I’ve said it before, these products become so complex that it’s nearly impossible to know if you’re paying too much for it. Companies make much higher margins on such complex products so it’s usually not a good deal to buy them:)

CEF’s: There are some good ones and I could see myself buying some but the problem is that these do not necessarily have good liquidity so I’d much prefer going for high quality dividend stocks at this point.

What I’d Invest In Through ETF’s or ETN’s

International Stocks: Any good income portfolio would hold international stocks. They provide great opportunities and some big companies such as Samsung, Nestle and dozens of others are not listed in the US so missing out on them would be a big issue. However, I personally have no interest in exchanging currency into all of those currencies, dealing with taxes, stamp fees, etc. So I prefer dealing with international ETF’s that will do the work for me.

Fixed Income: ETF’s are great for many different reasons but I’d argue that fixed income is the #1 use. Big funds are able to get much better pricing for their trades than individual investors making it a no-brainer. I strongly believe that only holding equities in an income portfolio is a mistake. Having both bonds and fixed income makes a lot of sense because bonds will perform better when the equity market declines and vice-versa.

Other Fixed Income: Less common types of fixed income products such as bank loans or mortgages can provide interesting levels of income and provide good value. Those are not possible to get without ETF’s though unless you’re in the 1%!

MLP’s: I’ve written about MLP’s before and while they do provide terrific yield and a different kind of exposure, I’d hesitate to buy them directly because of all of the taxes issues that are involved. Paying an ETF is the only option for me on MLP’s

Preferred Shares: The preferred shares market is highly illiquid and makes it very difficult for small investors like you and I to determine which ones are the better values. I’d much prefer paying a small fee in order to get a better execution and more diversification on these preferred shares

Stocks & REIT’s To Be Considered For Such A Portfolio

I did a few filters when trying to find quality and sustainable high paying stocks. I started off by looking for stocks that

-have a dvd yield of 4.50% or more
-tried excluding companies that had a special ex-dvd that does not seem recurring
-removed stocks with a payout ratio over 80%
-removed stocks with a mkt cap under $500M
-removed stocks with a debt/mkt cap ratio over 1

This gave me approx 30 names which I could potentially use in my portfolio:

And a few REIT’s:

My High Yield Portfolio

As I’ve mentioned, this is my first run at building a high yield sustainable portfolio so I’ll certainly make adjustments over time. Here are the asset allocations I was looking for:

International Stocks 15%
Fixed Income 20%
Other Fixed Income 5%
MLP’s: 5%
Preferred Shares: 5%
Domestic Stocks: 45%
REIT’s: 5%

This portfolio actually yields 5,09%! Not bad right?

I’d love to get your thoughts on the portfolio but also on the process of high yield portfolio construction