Retirement: The Near-Perfect Portfolio Revisited

Retirement: The Near-Perfect Portfolio Revisited

A few months ago, we wrote an article here on Seeking Alpha about a portfolio strategy that we like to call NPP (Near Perfect Portfolio) strategy. This was when the virus-induced countrywide lockdowns had just started, and the stock market and the broader economy looked in deep trouble. The future looked dark and uncertain. Don’t get us wrong. Some of those uncertainties in the broader economy still overhang even though the stock market has made a spectacular recovery. Nonetheless, the recent jobs report points to a much faster recovery than most economists had anticipated. However, one month does not make a trend, and the real question is if the progress on the jobs front continues in the coming months, or was it just a one-month wonder. The jury is still out there, and we would not know the answer for at least a few months.

What’s a Near-Perfect Portfolio?

No portfolio can be perfect, because it cannot meet all of its stated objectives in every situation all the time. No one can predict the future with any degree of certainty. The vast majority of predictions made by the so-called experts never pan out to be true. So, it’s up to an individual investor to take charge of their investments based on their temperament and personal situation. Sure, very young investors who have 25-40 years of time horizon can invest in the broader indexes like the S&P 500 and still do reasonably well in the long term, provided they are able to keep a check on their emotions and ride out through thick and thin. But the same cannot be said for retirees or older investors who do not have the luxury of time, or they have to withdraw income from their portfolios.

So, what should a retiree or anyone 50 years of age or older do? What’s the best way to stop worrying and losing sleep every time the market takes a deep dive? How can they preserve their capital, earn at least 5% income (if they need to withdraw), and at the same time, grow their investments to get a long-term total return of 10% (or higher)? We believe it’s possible to achieve all these three goals. That’s what we like to call a near-perfect portfolio strategy. Basically, we expect our near-perfect portfolio to achieve these three objectives:

  • Preserve capital by limiting the drawdowns to less than 20%.
  • Grow the capital for the long term at an annualized rate of 10% or more.
  • If needed, provide a consistent income of roughly 5%.

Diversification among various stocks and different sectors is good, but not merely enough because the stock market is inherently volatile. High volatility brings in all kinds of emotions and issues, including fear, selling at the wrong time, fear of missing out, and above all, overall low performance. So, our solution is to diversify in terms of investment strategies. By joining strategies that may perform divergent from each other under different market conditions would bring down the portfolio volatility and improve overall performance. This is the reason we combine three or four distinct strategies to form a highly-diverse, growth-oriented, and safe overall portfolio. The NPP portfolio combines monthly Rotational strategies with some buy-and-hold DGI (dividend growth investing) and high-income strategies to perform well in different market conditions. To provide some evidence, we will highlight a few details of how these portfolios performed during the recent market turmoil. This is not to brag about the performance of our portfolios (not all of them performed well), but to highlight the real potential of these strategies in conserving the capital during the times of extreme stress and panics while growing it in good times. This is especially important to the retirees and all other conservative investors.

We must caution that these strategies need some work on an ongoing basis and may not suit highly passive investors. In addition, they require patience. Obviously, nothing comes free, and one needs to make some extra efforts to achieve anything in life.

Before we go further, here’s the performance snapshot of our Rotational and buy-and-hold portfolios over the recent period. Performance is provided year-to-date:

Rotational Portfolios:

These portfolios behaved exceptionally well during the downturn and also during most of the recovery. None of them ever fell below -5%, compared to -30% for the broader market. However, after a nearly 40% market recovery, the broader market is playing catch-up. But as you can see, on average, all of the Rotational portfolios have preserved the capital, and a couple of them had exceptional gains.

Buy-and-Hold Portfolios:

There was nothing exceptional here. DGI-Core portfolio outperformed the market indexes only slightly by a few percentage points. However, there’s another significant advantage of the DGI portfolio over the market index. This portfolio provides a much more significant income (yield) than the S&P 500.

However, the other portfolio, “8%-Income CEF,” was a laggard at the market bottom and during most of the downturn, but has recently made great strides and has been playing catch-up in recent weeks. Many investments like energy, BDCs, and mortgage REITs were hit especially hard. Most investments in the energy sector are still down substantially, and the major reason for this portfolio’s underperformance.

How did the combined portfolio perform?

As you can see, Rotational and Buy-and-Hold portfolios behaved quite the opposite to each other during the panic, combining them would make a less volatile and more balanced portfolio. Let’s assume we had our overall portfolio (Near Perfect Portfolio) that was invested in the following proportions, prior to going into this recent crisis, and let’s see how it would have fared.

Note: The cash-like bucket is more relevant to retirees, near-retirees, or highly conservative investors.

At the worst point, the NPP portfolio lost about 12.5%, which is significant, but a lot less painful than 28% or 30%. As a whole, the NPP portfolio lost less than 50% compared to the S&P 500 in a really bad situation. Please note that at least half of the loss for NPP came because of a 15% allocation in the high-income strategy. Also, it’s important to note that NPP recovered much faster in the initial stages, and by mid-April, it only had a loss of 5%. Since now the market has mostly recovered, and if were to assume the bull run to continue, the NPP may lag the overall market slightly for the next couple of months.

How to Structure a Three-Basket (Bucket) Portfolio

The idea here is to provide the basic framework and leave the rest to the imagination and due diligence of the reader. For most conservative investors, we recommend adding the fourth bucket allocating 10% of the portfolio to cash-like investments. We always recommend moving to any new strategy only gradually over a period of time, by adding in small lots.

We would outline below a portfolio of three buckets if someone was to invest today.

Bucket 1: DGI-Core

We will provide a sample of 20 stocks that will likely provide the most resistance to downward pressure in an outright panic situation. There are many such companies that also pay good dividends. We will present a DGI portfolio of 20 such stocks. These stocks have been taken from one of our recent articles that highlighted stocks with the most resistance to downward pressure in case of a correction.


  • Long-term investments 4% dividend income
  • Long-term total return in line with the broader market
  • Drawdowns to be 65%-70% of the broader market.

In this bucket, we will invest roughly 35%-40% of the total investable funds. It will be our core investments in solid, blue-chip dividend stocks. It’s relatively easy to structure and form this bucket. Obviously, there can be many options. For more passive investors, they could just select some of the prominent low-cost dividend-ETFs and divide the amount equally among them. Sure, these ETFs charge ongoing fees, and the dividend yields will be slightly less, but it’s a trade-off for ease and simplicity.

The more active investors amongst us should go for carefully selected individual stocks. Roughly 30 stocks could provide more than enough diversification, though this will depend upon the size of the portfolio capital. For smaller size capital, 20-25 could be enough. Please note the diversification among various sectors and industry segments of the economy is still important.

A Sample DGI Portfolio:

Stocks selected:

(ADP), (AMGN), (CB), (CVX), (ED), (CVX), (ED), (JNJ), (KO), (MCD), (MO), (MSFT), (NNN), (OTCPK:NSRGY), (NVS), (O), (PEP), (PG), (T), (TXN), (UL), and (VTR).

Bucket 2: Rotational Portfolio

We recommend using more than one Rotation strategy. However, anyone who is just starting out, one such strategy may be appropriate as this does require some work on a monthly basis. As one gains more experience and confidence, one could diversify in multiple strategies. Below, we will just provide details on one such strategy.

So, what’s a Risk-Adjusted Rotation strategy, and why invest in it? There are many reasons that we can point out in favor of this kind of strategy. But foremost, this is our insurance bucket (or hedging bucket), which also would provide a decent return, good income, and preserve capital, all at the same time. This strategy rotates among a set of two securities and uses the “relative momentum” of each security to determine which one to invest in for the next holding period, usually a month. Please note that just because we are allocating 40% of the portfolio to this strategy, we are not recommending that you change to this strategy overnight with large sums of money. Rather, it should be done over time, and one should use more than one such strategy.

There can be several strategies or variations that one could employ. We provide one example below.

An Income Oriented Rotation Strategy with QQQX:

We are essentially looking for a portfolio that meets the following objectives:

  • Provide protection during nasty market corrections and limit drawdowns.
  • Provide high growth during both stable and bull-market environments.
  • Generate roughly 5% income on an average basis.

Most portfolios can meet one (or maybe two) of the above goals, but it’s tough to meet all three at the same time. Our Income-Oriented Risk-Adjusted Portfolio attempts to meet all three.

We will use only two securities in this portfolio:

  • (QQQX) Nuveen Nasdaq 100 Dynamic Overwrite Fund
  • (TLT) iShares 20+ Year Treasury Bond ETF

QQQX has a reasonably long history going back to January 2008, which incidentally covers the last recession of 2008-2009. It invests mainly in the top 100 Nasdaq stocks. We will provide the backtesting results using the QQQX/TLT. QQQX is a CEF and currently provides a quarterly distribution of roughly 7%. The yield has come down as the markets have surged recently, but even with a 7% dividend rate, we will likely generate a substantial income whenever we are invested in QQQX. Our backtesting shows that from 2008 to the present, we were invested for 86 months in QQQX out of a total of 149 months, roughly 60% of the time.

TLT is the 20-plus year Treasury Bond ETF that invests 95% of its assets in U.S. Treasuries with a maturity of 20-plus years. It currently provides a yield of roughly 1.80% on a monthly basis.

Every month we will compare the relative performance of these securities over the previous three months. We will select only one security (out of two) that has performed the best for the next month’s investment. We will repeat this process on a monthly basis.

Since January 2008 and until the end of May 2020, this strategy has provided an annualized return of 13.9%, compared with 8.2% of the S&P 500. However, the big difference is in the drawdowns. The strategy had a drawdown of about -20.5% compared to a whopping drawdown of -48.5% in the case of the S&P 500. The worst year performance since 2008 for the strategy was -5.9% compared to -37% for the S&P 500.

Note: We provide a similar but slightly enhanced version of this portfolio in our Marketplace service. The enhanced version aims for lower drawdowns.

Performance Chart – QQQX Rotation Strategy vs. S&P 500:

The first chart shows the performance in dollar terms (growth of $100,000), whereas the second chart shows the same with the impact of inflation-adjusted 6% withdrawals.

Now, if were to withdraw 6% income from the portfolio, the difference between the performance of the QQQX model and the S&P 500 becomes highly pronounced in favor of the Rotation model. It highlights the fact that if you were to withdraw income in a year that has a big drawdown, it would have a very negative impact on your long-term performance. So, it essentially becomes very important for retirees who depend on the portfolio income that they have some kind of protection or hedge in place to conserve the capital from huge drawdowns. We recently witnessed a similar situation in March 2020 when the market was down roughly 35%, while the QQQX rotation model was down only 7%-8%.

Drawdowns since the year 2008:

Performance comparison (from January 2008 – May 2020) of our Rotation strategy with the S&P 500 Index:

Bucket 3: High Income Bucket

At this moment, this may not sound to be a popular bucket. We also recognize that this is a relatively high-risk bucket. If you are a highly conservative and risk-averse investor, you should definitely avoid it. That said, some of the investments are still attractive at the present levels, though not nearly enough as they were a couple of months ago. Investors should keep in mind that some of these CEFs may cut or adjust their distributions in the next few months, so we need to be selective. Depending upon your income needs and risk profile, you could invest as little as 10% of your portfolio or maximum up to 25%. But for this article, we will assume 15% only.

We present a set of 10 high-income investment funds (CEFs, BDCs, REITs). Please note that over the last few weeks, the prices for these funds have come back, and yields have fallen but still at attractive levels. One should build the positions gradually over a period of time. The average yield of the portfolio presented below is roughly 9%.

The funds are (MAIN), (NLY), (UTF), (UTG), (PCI), (NMZ), (JPC), (STK), (HQH), and (KYN).

Concluding Thoughts

The Wall Street and the Main Street economy do not appear to be in sync. While the economy has re-opened or in the process of re-opening in almost all states, there’s still a long way to go to match the near full employment of pre-COVID levels. A lot of small businesses are still struggling to re-open and come back due to the double whammy of prolonged shutdowns and the recent violent protests in many major cities. There’s a lingering fear of a second wave of coronavirus in the fall and winter.

In spite of all these concerns and the wall of worries, the stock market has made a quick V-shaped recovery. We know that the stock market looks six to nine months into the future. The current exuberance is based on three factors: 1) The vast amount of liquidity provided by the Fed and $2 trillion of the stimulus package, 2) coronavirus pandemic is mostly behind us, and we are likely to have a successful vaccine before the end of the year, 3) interest rates will continue to stay near zero for at least a couple of years. All that said, no one really knows if we on the cusp of a new bull market, or are we going to muddle through a stagnant or down market. But that’s OK. As long-term investors, we do not need to lose our sleep on this.

We have presented above a diverse investing approach with multiple baskets which will provide an extra layer of safety and diversification. Above all, the combined portfolio should generate a very decent income of 5% and provide protection from huge drawdowns. Certainly, this approach would require more work than a simple index investing or just plain DGI investing. So, it may not be appropriate for everyone. The main idea is to get the readers to think about a multi-basket investment approach.

Disclosure: I am/we are long ABT, ABBV, JNJ, PFE, NVS, NVO, UNH, CL, CLX, GIS, UL, NSRGY, PG, KHC, ADM, MO, PM, BUD, KO, PEP, D, DEA, DEO, ENB, MCD, BAC, PRU, UPS, WMT, WBA, CVS, LOW, AAPL, IBM, CSCO, MSFT, INTC, T, VZ, VOD, CVX, XOM, VLO, ABB, ITW, MMM, LMT, LYB, ARCC, AWF, CHI, DNP, EVT, FFC, GOF, HCP, HQH, HTA, IIF, JPC, JPS, JRI, KYN, MAIN, NBB, NLY, NNN, O, OHI, PCI, PDI, PFF, RFI, RNP, STAG, STK, UTF, VTR, WPC, TLT. 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.

Additional disclosure: Disclaimer: The information presented in this article is for informational purposes only and in no way should be construed as financial advice or recommendation to buy or sell any stock. The author is not a financial advisor. Please always do further research and do your own due diligence before making any investments. Every effort has been made to present the data/information accurately; however, the author does not claim 100% accuracy. The stock portfolios presented here are model portfolios for demonstration purposes. For the complete list of our LONG positions, please see our profile on Seeking Alpha.

Originally published on Seeking Alpha

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