Maximizing Long-Term Income Through Diversification
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Maximizing Long-Term Income Through Diversification

In the previous article, we explored how diversification is the only “free lunch” on Wall Street, effectively reducing both fundamental risk and volatility. Today, we explore why it’s also crucial for maximizing long-term income.

Let’s begin with an extreme example: the single highest-yielding blue-chip stock on Wall Street.

MPLX, The Safest 9.5% Yield: Investing all your savings into MPLX (K-1 tax form) offers a secure 9.5% yield. Analysts expect this to grow at 3-5% over time, slightly ahead of the bond market’s 30-year inflation expectations of 2.5%. However, owning just one stock exposes you to concentrated fundamental risk.

MPLX’s BBB credit rating translates to a 7.5% risk of bankruptcy over 30 years, or a 1 in 13.3 chance of going to zero. MPLX’s total returns since November 2012 have been 9.42% CAGR, but this comes with volatility that is three times more than the S&P 500 and Vanguard’s high-yield ETF.

Annual Income on $1,000 Investment: MPLX has been consistently raising its payout each year. Including dividend reinvestment, it has seen incredible income growth over time. Its bear market actually helped compound this growth, turning a 3.8% yielding starter investment into an 18% yield on cost in just eight years.

Portfolio2013 Income Per $1,000 Investment2021 Income Per $1,000 InvestmentAnnual Income GrowthStarting Yield2021 Yield On Cost
S&P 500$24$489%2.4%4.8%
Vanguard High Yield ETF$36$8111%3.6%8.1%
MPLX$38$17721%3.8%17.7%

Harnessing Safe High-Yield with Diversification: By applying some simple screening criteria, we identified the four highest-yielding blue-chips for safe purchase today:

  • MPLX
  • Altria (MO)
  • Enterprise Products Partners (EPD)
  • British American Tobacco (BTI)

This diversified selection replaces a single 9.5% yielding MPLX with four blue-chips yielding 7.4% across three sectors. The quality of these picks is nearly as high as more renowned stock categories, offering a portfolio yield that’s three times as much as these renowned stocks. Analysts expect a 5% growth, driving a 13% long-term return.

High-Yield Blue-Chip Total Returns Since November 2012: 9.82% CAGR. Diversifying across these four high-yield blue-chips improved annual returns by 0.4% and halved both annual volatility and peak decline. The portfolio’s Sortino ratio, a measure of risk-adjusted return, increased by 26%.

Income Growth from Diversified High-Yield Stocks: Starting with a 6% yield, our portfolio’s end yield on cost was similar at 15%, with slightly slower income growth, but still nearly twice as fast as the S&P 500 and VYM.

Integrating Dividend Growth Stocks: Introducing dividend growth stocks into the mix showcases the power of diversification. We selected six hyper-growth dividend blue-chips, averaging a 1.6% yield but offering a 19.8% long-term return potential. These stocks include:

  • Lowe’s (LOW)
  • ASML Holdings (ASML)
  • Qualcomm (QCOM)
  • Taiwan Semi (TSM)
  • Mastercard (MA)
  • Visa (V)

Combining these with our high-yield picks, we created a portfolio yielding 3.9% with a 14.1% long-term growth consensus, resulting in a 18% long-term total return potential.

Inflation-Adjusted Consensus Return Potential: Even if the growth stocks in our portfolio grow as expected for just 5 years, we’re looking at potentially double inflation-adjusted returns over the next 10 years. The addition of dividend growth stocks doubled annual returns, reduced volatility, and lowered peak decline significantly. The portfolio’s Sortino ratio was twice as high as the high-yield blue-chips alone and substantially higher than both the S&P 500 and a 60/40 retirement portfolio.

Diversification into Growth Stocks: When we added Amazon (AMZN) and Autodesk to our portfolio, it diversified us into pure growth stocks. This combination elevated our portfolio’s long-term return potential to 16.5% CAGR.

The Road To $1 Million Portfolio: To turn our portfolio into a diversified and prudently risk-managed one, we adopted a strategy that involves a 33% allocation to index funds, 33% allocation to hedges (managed futures, bonds and cash) and 33% individual companies. The exact % vary week-by-week depending on market conditions, to improve asset allocation and maximize returns. Our bond choices include PIMCO 25+ Year Zero Coupon US Treasury (ZROZ), WisdomTree Floating Rate Treasury Fund (USFR) (cash), AB High Yield ETF (HYFI) for corporate bonds, and KFA Mount Lucas Managed Futures Index (KMLM) for the managed futures.

The Road To $1 Million Portfolio Performance During Market Crises: Backtesting a portfolio similar to the Road To $1 Million one consisting of a 33/33/33 allocation during various market crises, including the Great Recession and the 2020 Pandemic, resulted in a remarkable performance. It consistently showed less volatility and smaller peak declines compared to traditional portfolios.

Future Expectations from a similar portfolio: Analysts predict that a portfolio similarly constructed will continue to deliver superior yields and long-term returns, with significantly lower volatility and peak declines compared to other investment strategies. You can track the performance (updated roughly every 2 weeks) in terms of total returns of the Road To $1 Million portfolio in the upper section of every page on our website. Soon our premium users that follow our investment journey will be provided with more detailed charts to track both total returns as well as income growth over time.

Conclusion:

Diversified Growth and Value are the Keys to increased Income: The combination of diversified growth and value, exemplified in our Road To $1 Million portfolio, offers a compelling approach to achieving maximum income. This strategy balances high yields today with the potential for market-beating long-term returns, lower volatility, and reduced peak declines in market crashes. The portfolio not only presents a prudent path to financial security but also demonstrates the power of disciplined financial science in navigating any economic or market condition.

Road To $1 Million

Start Date: 04/17/2023

As of 04/19/2024:

  • Portfolio Value: $26,682
  • Left to reach $1M: $973,318

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