JamesBrey
Investing in high-yield, low-risk dividend stocks is a popular strategy with many retirees and conservative-oriented investors due to its focus on generating dependable passive income while simultaneously preserving or even growing principal over the long term.
In contrast to growth stocks that generate their entire total return through capital appreciation, dividend stocks generate total returns through a combination of dividend payments and potential long-term capital appreciation. This can help to mitigate the sequence of returns risk because dividend payments tend to be much more dependable than stock price appreciation. Therefore, for investors who need to make regular withdrawals from their portfolios to fund living expenses, living off of dividends can help them sleep well at night knowing that they will never have to sell shares during a market downturn.
However, building a high-yield low-risk portfolio requires understanding how to select stocks that pay dependable dividends, how to diversify your portfolio sufficiently, and how to manage the portfolio to adapt to changing economic conditions. This article will provide a concise tutorial towards this end.
Criteria for Selecting Dividend Stocks
Building a high-yield, low-risk dividend portfolio depends on successfully selecting the right stocks. As we detailed in a recent article, the four key criteria are:
- Defensive and Durable Business Models: Companies whose operations are essential, generate relatively stable cash flows through various business cycles and are relatively immune to technological disruption are great choices for high-yield, low-risk dividend portfolios. Companies in the utility (XLU), real estate (VNQ), infrastructure (UTF), and midstream (AMLP) sectors are typically great options for meeting this criteria.
- Strong Balance Sheets: It is also important to insist on companies with low debt levels, well-laddered debt maturities, and substantial liquidity (often – though not always – evidenced by investment-grade credit ratings) because during periods of macroeconomic uncertainty and/or severe industry headwinds, companies with significant leverage often resort to cutting their dividends. When it comes to the dividend vs. the balance sheet, prudent management teams will choose to save their balance sheet every time. For an investor looking to live off of dividend income, this is a scenario that must be avoided.
- Sufficient Dividend Coverage and Growth: Another key component to enjoying a low-risk dividend income stream is ensuring that the companies comfortably cover their dividend payouts with cash flow. If not, the company may have to cut its dividend in the future in order to ensure that they are not depleting its balance sheet to support it. Additionally, it is important to make sure that the company has the capacity and the intent to grow its dividend in the future at a pace that at least matches the expected rate of inflation in order to protect the purchasing power of the passive income stream.
- High Dividend Yield: Last, but not least, for an investor who is looking to live off of passive income from dividends, it is important to ensure that the dividend stocks have a high enough dividend yield to cover expected living expenses with dividend passive income.
Diversification Strategies
In addition to selecting the right individual dividend stocks, proper diversification is key to mitigating risk. By spreading investments across various sectors and geographic regions, investors can minimize the risk of dramatic declines in their dividend income stream in the face of an uncertain future.
The importance of diversifying across sectors was clearly illustrated during the COVID-19 lockdowns. Several high-yielding investment-grade stocks in sectors like retail real estate and energy (XLE) – such as Simon Property Group (SPG) and Energy Transfer (ET) – slashed their dividends during the lockdowns in response to substantial headwinds that were unique to their sectors. Given this uncertainty about the future, it is essential to diversify across different business segments.
The importance of diversifying across geographic regions was recently demonstrated by the war in Ukraine and the growing geopolitical and macroeconomic uncertainty in China. Investors who invested aggressively in Europe before Russia’s invasion of Ukraine suffered materially underperformance in the wake of that invasion while investors who have piled into Chinese public markets like Alibaba (BABA) have gotten crushed in recent years.
Investing In Stocks Vs. Funds
To build an effectively diversified portfolio of high-yield, low-risk stocks, investors can take one of three paths:
- Invest in broadly diversified high-yield funds.
- Invest in a diversified basket of high-yield, low-risk stocks.
- Invest in a combination of the two.
We recently wrote several articles that discussed several high-yielding funds, including monthly-paying dividend funds like the Virtus InfraCap U.S. Preferred Stock ETF (PFFA), the JPMorgan Equity Premium Income ETF (JEPI), and the Neos S&P 500(R) High Income ETF (SPYI). We also discussed some high-yield CEFs with strong track records like the Cohen & Steers Quality Income Realty Fund (RQI), the Cohen & Steers Infrastructure Fund (UTF), Reaves Utility Income Trust (UTG), and the Neuberger Berman Energy Infrastructure and Income Fund (NML). Finally, we discussed several quality, low-cost dividend growth ETFs like the Schwab U.S. Dividend Equity ETF (SCHD), the Vanguard Dividend Appreciation Index Fund ETF Shares (VIG), the Vanguard High Dividend Yield Index Fund ETF (VYM), and the iShares Core Dividend Growth ETF (DGRO). We discussed a way to put some of these together into a portfolio in a recent article titled A 5%-Yielding Portfolio With 9% Dividend Growth.
We also have written numerous articles with lists of attractive-yielding, high-quality dividend stocks, including a recent one that detailed Realty Income Stock (O), Enbridge Stock (ENB), and Blackstone Secured Lending Fund Stock (BXSL). Perhaps the best overall low-risk, high-yielding retirement individual stock opportunities in our view at the moment include Enterprise Products Partners (EPD), Brookfield Infrastructure Partners (BIP)(BIPC), and Brookfield Renewable Partners (BEP)(BEPC).
Finally, blending the two into a well-diversified portfolio can also make a lot of sense, as we detailed in recent articles such as A $100,000 Dividend Snowball From A 5.5%-Yielding All-Weather Portfolio and A 9%-Yielding Portfolio With Low-Risk Dividends For Sustainable Passive Income.
Investor Takeaway
Investing in well-diversified portfolios of high-yielding, low-risk dividend stocks is a sound way to compound wealth over the long-term while also generating substantial passive income for retirement. There are numerous paths to achieving this, but there are also some non-negotiable principles that must be followed for long-term success when using this strategy. Hopefully this article gave you some of those bedrock principles while also giving you numerous ideas and strategies as food for thought as you plan your own high-yielding, low-risk dividend portfolio.
