How To Build A 6% Yielding Sleep Well At Night Retirement Portfolio With These 15 Blue-Chips (2024)

(Source: imgflip)

In my recent article, I explained the 3 safest 8+% yielding blue-chips retirees can trust in this recession.

In the comments, a reader asked me to do an article explaining how to not just select safe ultra-high yield blue-chips but also construct a fully diversified and prudently risk-managed portfolio that yields at least 5%.

The good news is that prudent risk management, such as the guidelines that Dividend Kings uses in all five of its portfolios (I also use it for my retirement portfolio) provides the flexibility for meeting a wide variety of immediate as well as long-term income needs.

Using these guidelines, which have been constructed over my six years as an analyst and with the input of professional asset managers with over 60 years of experience (who manage over $150 million for clients), we can safely build

• portfolios with 3% to 6% yields
• long-term dividend growth forecasts of 5% to 12%
• that is fairly valued or better (even with the S&P 500 at the highest valuations in 19 years).

The overall goal of any portfolio is to meet clear goals that work for your personal risk profile.

Over the long-term, just three things determine total returns, which include dividends.

These are starting yield, long-term earnings/cash flow growth (which dividends track), and changes in valuation.

(Source: Ploutos)

If you focus just on yield, long-term growth potential, and reasonable to attractive valuation, you're halfway to accomplishing your goals.

The other half of successful investing is risk management. Why?

Because while stocks are the best performing asset class in history, they don't go up in a straight line.

(Source: Advisor Perspectives)

The average intra-year market decline since 1990 is 13%, and since 1945 and 2009 the market has averaged a 5+% decline every six months.

(Source: Guggenheim Partners)

While most pullbacks and corrections are short, with stocks recovering to new highs within two months, and eight months, respectively, long bear markets do occur periodically.

When stocks can be underwater for as long as seven years, it's vital that your portfolio is strong enough to avoid becoming a forced seller. That's either for financial, or emotional reasons.

(Source: Lance Roberts, Dalbar)

75% of historically terrible investor returns are the result of improper asset allocation, meaning not having sufficient cash/bonds to smooth out portfolio volatility and allow you to fund expenses without selling stocks.

Becoming a forced seller, or merely attempting to time the market, is why investors earned 2.5% CAGR returns over the last 20 years. That's just 0.3% above the rate of inflation and worse than buying and holding almost any asset class.

So now let me show you how to find not just the safest high-yield blue-chips you can trust for a portfolio, but more importantly, how to construct one that can withstand virtually every realistic economic, market, and pandemic scenario.

Step 1: Finding The Safest High-Yielding Companies We Can Trust

(Source: Dividend Kings Research Terminal)

The Dividend Kings Research Terminal allows our members to easily find the best companies for any combination of needs, goals, and risk profiles.

It updates in real-time and is color-coded by

• green: potentially good buy or better
• blue: potentially reasonable buy
• yellow: hold
• red: potential sell/trim

The color coding is updated daily and based on the following criteria, requiring a sufficient margin of safety based on a company's quality and risk profile.

For our high-yield balanced 6% yielding sleep well at night or SWAN portfolio, I'll begin by selecting only 9+11 quality blue-chips. For context, the average dividend aristocrat has 9.6/11 quality and the average dividend king 9.5.

I'll also select for only 4+/5 dividend safety.

I determine dividend-cut risk based on historical dividend cuts during previous recessions.

(Source: Moon Capital Management, NBER, Multipl.com)

Then I adjust the probability of a dividend cut based on the 4X to 6X increased severity of this recession, according to the blue-chip economist consensus (and Federal Reserve forecasts).

So now that you understand why we're targeting just 9+11 quality blue-chips or better, with 4+5 above-average safety or better, let's determine how many companies we need to buy.

In Step 3, we'll select the safest high-yield blue-chips to construct our 6% yielding bunker portfolio to help retirees sleep well at night. But first, we need to determine how many companies to buy in total.

Step 2: How Much Diversification Do We Need?

Many studies have been done about the effects of diversification, which is often called "the only free lunch on Wall Street".

(Source: Journal of Finance, Malkiel et. al)

(Source: Fisher et al, The Journal Of Business)

In terms of volatility risk, owning

• 2 stocks reduce annual volatility by 46%
• 10 stocks reduce annual volatility by 80%
• 32 stocks reduce annual volatility by 95%

The Dividend Kings risk-management guidelines recommend owning at least 15 blue-chip companies within at least 5 sectors, to minimize individual company/sector fundamental risk.

Most investors find that 20 to 30 companies are manageable and those with a passion for checking up on their blue-chips on an annual basis can own as many as 60.

• I own 75 companies
• Chuck Carnevale owns 69 in his clients' portfolios (he manages over $130 million in his asset management firm)
• my fellow Dividend King Nick Ward owns about 60 companies in his portfolio
• Berkshire owns 47 companies.

You don't necessarily have to buy all your companies at once, nor do you need to equally weight them.

Chuck, Nick, and I have been steadily buying quality companies over many years (over 15 for Chuck) opportunistically, which is why we own so many.

15 to 30 is a good rule of thumb for most people, so let's use that to construct our high-yield bunker SWAN portfolio.

Step 3: Selecting Our High-Yield Blue-Chips

I selected the following companies by the following criteria.

• highest yielding stocks
• that are 9+/11 blue-chip quality or better
• that have 4+5 dividend safety
• that are potentially good buys or better
• exclude oil producers due to uncertainty surrounding short to medium-term oil prices (all oil producers are speculative)

I thus found the following high-yield blue-chips, SWANs, and Super SWANs, merely by using the Master List in the DK research terminal and sorting by yield.

First, let's see what the 21 highest yielding blue-chips are, to see if we can safely build a sufficiently diversified but relatively concentrated high-yield portfolio.

1. Enterprise Products Partners (EPD): 9.8% yield, 11/11 quality Super SWAN
2. Altria (MO): 8.6% yield, 9/11 quality blue-chip dividend king
3. Enbridge (ENB): 7.6% yield, 11/11 quality Super SWAN
4. Pembina Pipeline Corp (PBA): 7.5% yield, 10/11 SWAN quality
5. Prudential Financial (PRU): 7.2% yield, 9/11 blue-chip quality
6. Philip Morris International (PM): 6.7% yield, 10/11 SWAN quality
7. British American Tobacco (BTI): 6.6 yield, 9/11 quality blue-chip
8. Canadian Imperial Bank of Commerce (CM): 6.3% yield, 9/11 quality blue-chip
9. Bank of Nova Scotia (BNS): 6.3% yield, 9/11 quality blue-chip
10. Bank of Montreal (BMO): 5.8% yield, 9/11 quality blue-chip
11. TC Energy (TRP): 5.7% yield, 10/11 quality SWAN stock
12. Toronto-Dominion Bank (TD), 5.2% yield, 10/11 quality SWAN stock
13. Metlife (MET): 5.0% yield, 9/11 quality blue-chip
14. AbbVie (ABBV): 4.8% yield, 9/11 quality blue-chip dividend aristocrat
15. Dominion Energy (D): 4.6% yield, 10/11 quality SWAN
16. National Fuel Gas (NFG): 4.4% yield 9/11 blue-chip dividend king
17. AvalonBay Communities (AVB): 4.0% yield, 10/11 SWAN stock
18. Extra Space Storage (EXR): 3.7% yield, 9/11 quality blue-chip
19. 3M (MMM): 3.8% yield, 10/11 SWAN dividend king
20. MDU Resources (MDU): 3.7% yield, 9/11 quality dividend champion
21. Essex Property Trust (ESS): 3.5% yield, 9/11 quality dividend aristocrat

Theoretically, we could simply buy equal amounts of all 21 of these companies.

BUT we can't forget about sector diversification.

• 6/21 are financial: 29% sector concentration
• 4/21 are energy: 19% sector concentration
• 3/21 are consumer staples: 15% sector concentration and 15% industry concentration
• 1 healthcare = 5% weighting
• 1 utility = 5% weighting

But this is where the power of selectively weighting companies comes in.

Remember that the primary goal of this article is maximizing safe high-yield, not just from individual companies but across the entire portfolio.

Thus from those 21 companies, we can start weighting by the maximum 7% guideline in the highest yielding names remembering 20% sector caps and 15% industry caps.

This portfolio has exposure to seven sectors, with none over 20% and no industry more than 14%.

Its average yield is 5.7%, with average long-term analyst growth consensus of 6.3% and a probability-weighted expected return of 11.3%.

What are probability-weighted expected returns?

(Source: Dividend Kings Investment Decision Tool)

It means applying the historical 30% margin of error to the Gordon Dividend Growth model.

That's because we don't know whether a stock will be in a bubble or a bear market in five years when sentiment still determines 55% of total returns.

There is also a 20% to 40% probability for any given company that analysts are just wrong about the growth consensus range, which already factors in historical margins of errors.

The mid-range probability-weighted expected return is a sensible expected return for a company that factors in both that

• we can't predict sentiment five years from now (whether or not a company will be fairly valued, overvalued, or undervalued)
• we can't know which companies analysts will be dead wrong about, in terms of how they grow (factoring in industry disruption and other business model risks).

So now let's consider how our weightings of these 15 dividend blue-chips affect the final equity portion of our portfolio.

The overall portfolio is quite attractive from a fundamental perspective.

• 5.7% weighted yield
• 6.3% weighted consensus long-term growth (dividend growth will approximate this over time)
• 27% weighted discount to fair value
• 11.4% CAGR probability-weighted expected return.
• Probability-expected return 153% more than S&P 500's 4.5% CAGR

Remember how I said you could build a safe portfolio of 3% to 6% using the Dividend Kings risk management guidelines? This is how you do that. By maxing out the safe weighting of the highest yielding blue-chips in each sector and industry.

However, remember that we're seeking a SWAN retirement portfolio that can stand up to any realistic economic/market outcome in not just this recession, but future ones as well.

So here are the fundamental stats of this 15 high-yield blue-chip portfolio.

Fundamental Stats On This Portfolio

• Average quality score: 9.5/11 Blue-chip quality vs. 9.6 average dividend aristocrat
• Average dividend safety score: 4.5/5 very safe vs. 4.5 average dividend aristocrat (about 2.5% dividend cut risk in this recession)
• Average FCF payout ratio: 67% vs. 73% industry safety guideline
• Average debt/capital: 49% vs. 53% industry safety guideline vs. 37% S&P 500
• Average dividend growth streak: 22.2 years vs. 25+ aristocrats, 20+ Graham Standard of Excellence
• Average 5-year dividend growth rate: 8.7% CAGR vs. 8.3% CAGR average aristocrat
• Average forward P/E: 12.7 vs. 21.2 S&P 500
• Average earnings yield: 7.9% vs. 4.7%% S&P 500
• Average PEG ratio: 2.38 vs. 3.22 historical vs. 2.48 S&P 500
• The average return on capital: 260% (88% Industry Percentile, Very High Quality/Wide Moat according to Joel Greenblatt)
• Average 13-year median ROC: 200% (relatively stable moat/quality)
• Average 5-year ROC trend: 0% CAGR (relatively stable moat/quality)
• Average S&P credit rating: BBB+ vs. A- average aristocrat (5% 30-year bankruptcy risk)
• Average annual volatility: 23.3% vs. 22.5% average aristocrat (and 26% average Master List stock)
• Average Market Cap: $51 billion large-cap

This portfolio is objectively very high quality, nearly on par with the dividend aristocrats, and it yields almost 2.5X as much.

And as we just saw, the 26% discount to fair value results in double-digit probability-weighted expected returns that about 150% greater than that of the S&P 500 or the dividend aristocrats.

How smart would it be to invest the EQUITY portion of one's portfolio into these 15 companies right now?

We can do a full portfolio Investment Decision Analysis by applying the Dividend Kings Investment Tool to this diversified and prudently risk-managed portfolio.

Putting It All Together

S&P credit ratings have a strong correlation with long-term bankruptcy risk.

(Source: Dividend Kings Investment Decision Tool, S&P, The University of St. Petersberg)

This is why they serve as the proxy for the risk of permanently losing your money when a company goes bankrupt and the stock becomes worthless.

(Source: Dividend Kings Investment Decision Tool)

I use a 7 point rating scale to rank all companies, even those without a credit rating.

I estimate effective implied credit ratings by looking at

• debt metrics using credit rating guidelines
• advanced accounting metrics that estimate short and long-term bankruptcy risk and accounting fraud risk
• the average long-term borrowing costs of the company compared to long-term average bond yields by credit rating

Lincoln Electric (LECO) Is An Unrated Super SWAN Aristocrat With An Effective A-credit rating

(Source: Ycharts)

The BBB+ weighted credit rating of this portfolio means it scores a 6/7 in the Investment Decision Tool.

I then compare a company or portfolio expected dividend and total returns to the S&P 500, many people's default alternative.

(Source: Dividend Kings Investment Decision Tool)

Here is how this portfolio does under these criteria.

Dividend Return Matrix

(Source: Dividend Kings Investment Decision Tool

These 15 companies are expected to generate about 34% dividend returns over the next five years, or about triple that of the S&P 500. That scores a 10/10.

Total Return Potential Matrix

(Source: Dividend Kings Investment Decision Tool)

The expected returns of this portfolio are over 150% superior to those of the S&P 500, which is why this portfolios scores a 10/10.

And last but not least, we can't forget that valuation always matters.

(Source: Dividend Kings Investment Decision Tool)

So now let's consider how this portfolio of 15 high-yielding blue-chips looks like when we consider every single important fundamental metric that determines long-term investing success.

This Portfolio Decision Matrix

But don't just run out and put all your life savings into these 15 high-yield blue-chips. Because we're not yet done building our SWAN retirement portfolio.

Step 4: Don't Forget About Prudent Asset Allocation

How have these companies performed in the past? Well over the long-term the market is never wrong, because as Ben Graham said the market always correctly "weighs the substance of a company."

This Portfolio's Total Returns Since 2005 (Annual Rebalancing)

(Source: Portfolio Visualizer)

These 15 blue-chips did a great job of delivering safe income over the last 15 years while delivering superior volatility-adjusted total returns.

BUT that doesn't mean that anyone that owned just these 15 companies didn't potentially lose sleep during periods of intense market volatility.

(Source: Portfolio Visualizer)

The S&P took almost five years to get back to record highs following the Great Recession. This portfolio took just two years and fell about 5% less at its peak.

But if you couldn't live purely off dividends during those two years, then you might have become a forced seller, of high-quality companies trading at irrational prices.

So here is where the power of cash/bonds comes in.

Here's what happened since January 2008, the start of the Great Recession if you allocated 70% of your portfolio to those 15 blue-chips, and 15% to cash (BIL), and long-duration US treasuries (SPTL).

Balanced 15 Portfolio Blue-Chip Portfolio Since January 2008 (Annual Rebalancing)

(Source: Portfolio Visualizer)

This balanced portfolio managed to deliver superior returns and far more dividends during the last 12 years, while performing slightly better during the Great Recession, compared against a 60/40 stock/bond portfolio.

(Source: Portfolio Visualizer)

Now during this bear market, this portfolio did underperform the 60/40 balanced portfolio, by 2.8%.

• but it only fell 15% vs 26% without bonds/cash
• it hasn't suffered a single correction outside of recessions in 12 years
• not even a correction in December 2018 when stocks fell 17% in 3 weeks

THIS is what I mean by a SWAN portfolio. A combination of blue-chips and prudent asset allocation into cash/bond based on your personal risk profile.

If you can truly stomach periods of intense high volatility AND your portfolio is generating sufficient income that dividends + social security and private pensions cover living expenses, then being 100% in stocks is OK.

For most people, however, seeing a 26% decline in a month (or 45% during the Great Recession) is simply too much to stand emotionally.

Which is why the goal of any portfolio isn't maximizing absolute returns, but to generate sufficient returns while sustaining only as much volatility as you can personally stomach.

Any plan you can't stick to will prove worthless in the long-term.

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Bottom Line: Building A Safe 6% Yielding Portfolio Is Possible...If You Have The Right Approach And The Right Tools

I hope you've found this article exploring the safe way to maximize yield while maintaining sound risk management enlightening.

The essence of successful long-term investing is not luck, but a disciplined application of sound, evidence-based practices that are most likely to achieve your personal financial goals.

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You're neither right nor wrong because other people agree with you. You're right because your facts are right and your reasoning is right—and that's the only thing that makes you right." - Warren Buffett

Risk management is what saves us when the facts turn against us, as they will periodically. Usually not to the extent that a company fails entirely, but occasionally a blue-chip will fail.

This is where your reasoning and risk management makes all the difference.

EPD, ENB, MO, PRU, BTI, BNS, BMO, ABBV, D, NFG, AVB, EXR, MMM, MDU, and ESS are unquestionably high-quality blue-chips when we examine their safety metrics, including debt levels, credit ratings, dividend growth streaks, and returns on capital.

And a portfolio I've shown today, that's approximately (though not entirely) equally weighted between them, will yield a safe 5.7%. It's also expected to deliver low double-digit long-term returns courtesy of about 6% CAGR dividend growth.

But don't forget that all stocks are volatile, and none are true bond alternatives. Only take on as much equity risk as your temperate and risk profile can stand.

What's most important is the overall approach to sound portfolio construction, and management, which will see us through whatever happens next with the economy, pandemic, or stock market.

(Source: AZ quotes)

Gamblers pray for luck, disciplined long-term investors make their own, through patience and a focus on quality first and prudent valuation & risk management always.