Staying the Course with Conservative Income Investing

I ask myself almost every week whether I should be more aggressive with my investing.

For five years, I have followed a path of investing almost exclusively in term preferred stocks and baby bonds with maturities of less than 10 years. The idea is to reduce volatility, have a “date certain” for maturity and provide a reasonably good return.

We have thought for quite a few years that following the plan outlined above was the appropriate plan for us. It provides the potential for a fairly good return of 6-8% in an economy that is modestly positive, as well as offers less risk than buying dividend-paying common stocks.  Remember that just a couple years ago bank savings earned nothing, certificates of deposit (CDs) paid very little and income investors struggled to find yield.

 Our goal has been to achieve a 7% return on a consistent basis. To date, this has been a reasonable goal that was achievable. With a low inflation rate, most individual investors should be happy with a consistent 7% return. A recent study by Dalbar Inc. shows that the average individual investor attains only a return of 5.19% over a 20-year period. In the end, most individuals simply “buy high” and “sell low,” which is the opposite of what one hopes to do when investing.

Investors need to know themselves and know how they react to losses. We know ourselves fairly well after almost 50 years of investing, and we know that the older we get and the closer the time that we will depend upon our investing to help us in retirement, the more conservatively we invest. The time when we could sustain losses — with the knowledge that over the very long term common stocks would appreciate nicely — is over for us.

With the experience of the last number of years, as well as continual maintenance of our model portfolios, we continue to refine our approach to investing.

As readers of our articles over the years will recall, we have maintained two model income portfolios which have been the foundation of our personal investing. While these models are not identical to our personal holdings, they are extremely similar.

The first model, which we call the Short/Medium Duration Income Portfolio, was originally formed in October of 2014. The guidelines for this portfolio have not changed since formation and primarily dictate that only shorter maturity instruments shall be held, and that issues will not be traded except in rare instances.

Over the 3 ½ years since inception, the Short/Medium Duration Portfolio has achieved a total return of almost 24% and would seem to be on track to achieve a total return of 26-27% at the four-year mark.

There have only been two true security sales from this portfolio, although there have been many issues called for redemption. At the time of inception, we never would have thought that interest rates would remain as low as they have and that so many issues would be “refinanced” at even lower coupons. This has made it an ongoing challenge to remain nearly fully invested within the parameters of our “rules.” But in the end, we have been very happy with the return on this low stress portfolio. The reason we say low stress is because the volatility of shorter duration securities is much lower than perpetual preferred securities. Additionally, the pressure to trade issues is reduced to a minimum.

In addition to the above portfolio, we have another favorite, which is the Medium Duration Income Portfolio with Zip. For all practical purposes, this is the same portfolio as the Short/Medium Duration Income Portfolio with one important difference. This portfolio typically contains at least one real estate investment trust (REIT) or master limited partnership (MLP), which is meant to provide some “zip,” although on occasion it provides some “zap,” as one can’t hold one or two of these issues and not add risk to the portfolio.

Thus far, this portfolio has provided the extra zip we had hoped for with the added REIT issues.  The portfolio has held apartment REIT Independence Realty Trust (NYSE:IRT) on three separate occasions. The first 2 times, IRT was sold for approximately 10% capital gains. The model currently holds this issue again. Additionally, New Residential Investment (NYSE:NRZ) was held and sold for a large capital gain.

This portfolio was originally constructed on 8/13/2015 and is approaching its 3rd anniversary.  Presently the portfolio has a total return of 21.78% and it is likely that a return of 23% will be achieved in the 3 year period.

While these portfolios have not been tested in recessionary times yet they are a bit of a longer term example of what can be achieved without the use of common stock investments.  Not every investment in these portfolios has done well, but over the longer term these types of problems smooth themselves out.  We plan to continue to maintain these portfolios into the future so we build more knowledge on longer term investing using only shorter duration securities.

Additionally, no one would argue that the issues in these portfolios are high quality, because mostly they are not.  Remember we have been in a world of extremely low interest rates where one earned nothing in a savings account or a CD and a modest level of risk has to be incurred to earn a reasonable return.

In summary long-term investing can provide even a conservative investor a decent return.  A commitment to a plan is normally required and the plan needs to be executed.  The returns shown above are more than adequate for us,  although the plan is likely too conservative for younger investors and too risky for some.