Alternative investments are popular topics of conversation these days, and rightfully so. Equity markets have been volatile, fixed-income investing isn't as productive as it used to be, and according to a variety of surveys and research, correlations are on the rise. Advisors need to find other ways to diversify client portfolios to generate needed income without exposing clients to too much market risk.
Personally, I've explored a number of alternative strategies and investments but found problems with them, including the fact that they break two of my deepest held investment beliefs:
1) If you can't explain it you shouldn't own it.
2) Every investment should have, a buy, sell and hold price.
Alternative investments have become an interesting wrinkle in the life of advisors. In the not too distant past, they were only available to wealthy, sophisticated clients who understood the risks associated with them. Now that they are available to more clients who aren't so well informed, advisors are faced with the difficult tasks of balancing the risks and diversification benefits from these strategies, as well as monitoring them and communicating the details to clients.
Instead of trying to stretch for yield, take on too much risk, or increase the time I spend monitoring new, alternative investments, I've opted for a couple of alternative retirement income strategies that are easy for clients to grasp and offer advisors the opportunity to add similar value as those pitching more complex approaches.
It's important to point out that no one strategy is right for every client, and in most cases, any one strategy should constitute less than 10 percent of an overall portfolio. It's also significant that alternative investment strategies are designed primarily to create income, reduce market risk relative to Modern Portfolio Theory (MPT) measures, and be psychologically satisfying -- clients feel secure in employing these strategies based on realistic knowledge and expectations about them.
Low Correlation Dividend-Paying Stocks
Instead of turning to alternative investments for income, advisors can turn to low correlation stocks such as Annaly Capital Management (NLY), Exelon (EXC), and Kimberley Clark (KMB).
Generally, an investment with a correlation below .50 is considered to be a low correlation option. The three stocks listed below carry dividend yields well above those of popular dividend-paying ETFs such as Vanguard Dividend Appreciation (VIG) and Vanguard High Dividend (VYM), as you can see in the table. Furthermore, their individual and mean correlations are well below those of the Dow and the S&P 500 (SPDR S&P 500 (SPY) and SPDR Dow Jones Industrial Average (DIA) are proxies for the indexes).
Combined the three companies' correlations are in line with that of the popular fixed-income investment Pimco Total Return Fund (PTTRX). There are some other risk-associated advantages of a bond fund compared with individual stocks, but the point is to illustrate how using a sub asset class of large-cap dividend-paying stocks can provide diversification similar to a bond fund while providing income.
Timing The MarketPeople may say you can't time the market, but I believe you can if you look at it through the correct lens. Instead of trying to pick market tops and bottoms, advisors can use dividend-paying stocks to time the market relative to a client's needs and situation.
In the old days, I wasn't embarrassed to tout a bond or CD yield, and use them in combination to match payment dates with financial events or generate retirement income. For example, in Michigan property taxes are usually paid twice per year. I could therefore use short-term CDs or bonds with payments in corresponding months to support or offset client withdrawal needs. But with interest rates so low, advisors may need to consider dividend-paying stocks for these kind of goals. Many clients (and even some advisors) don't realize that different companies pay their dividends in different months of each quarter. By matching the payment of company dividends to when withdrawals are required, advisors can help clients offset or lessen withdrawals of other funds.
Likewise, you can use the time of year and current economic environment to add yield and give your clients a fresh perspective. Heading into September, for example, we wanted to seek out some additional income strategies for clients before yea-rend, but we weren't sure if Ben Bernanke would come through with QE3 or if Mario Draghi would fulfill his promise to save the Euro "no matter what."
Therefore, we focused our first phase of income timing on dividend-paying companies with yields above 3% and those companies that had two dividend payments remaining this year (September and again in December). On top of that, we wanted to ensure we used low-risk companies and those with good shock value, because if there was no QE3 or Greece left the Euro, there could be a ripple across the markets similar to the collapse of Lehman Brothers in September 2008.