How To Earn 7% Passive Income With 10 Funds Portfolio (2024)

Introduction:

We generally write about individual stocks that pay growing dividends. We also frequently advocate having a diversified multi-bucket system. These buckets usually have different goals and objectives, providing an overall well-rounded portfolio. But in the process, we end up with at least 30 stocks and securities, sometimes even more. There are certainly many advantages of having such a portfolio, which range from almost no fees to growing dividends and aiming for market-beating returns.

But let's face it. Not everyone is interested in researching, holding, and then monitoring 30-40 individual stocks and securities. Some people do not have the time, others do not have much interest, and then there are others who just want to keep it simple for themselves and their heirs. Even then, they still need and want their investments to provide high income in a sustainable and relatively safe way during their retirement years.

Keeping these needs and objectives in mind, in this article, we present a simple portfolio consisting of ten funds/securities that, in our view, form a moderately conservative, relatively safe, and diversified portfolio that can provide life-long high-income and beat inflation at the same time.

Why Just 10 Funds (Are We Diversified Enough)?

There is nothing special about having just ten Funds. It can be 12 or 15 funds. We could be okay with fewer than 10. It depends on what we have inside those funds. Each of these funds has tens or hundreds of individual stocks or securities. In fact, if we look at all the funds that we are going to present, in totality, they have more than 2000 individual stocks or securities, covering the majority of industry segments, almost all of the sectors, and many asset classes. We think that is good enough for diversification. Some of the underlying asset classes tend to behave differently under different economic environments, making the portfolio less volatile.

The Portfolio:

The table below presents the portfolio of 10 funds. Please note that we have also included two broader market exchange-traded funds, or ETFs, that are NOT known to pay much income. We are allocating 10% each to the SPDR® S&P 500 ETF Trust (SPY) and Nasdaq 100-Index-focused Invesco QQQ Trust ETF (QQQ) in order to balance out the concerns of long-term growth. We all know how important income is in retirement, but it is also critical that our portfolio beats inflation and grows with time. Considering the fact that retirements can last 30 years or more, we want our money to outlast us and not the other way around.

Now currently, this portfolio yields slightly less than 7%, and that is because the market is nearly at the top. However, if these funds are acquired opportunistically when the market is a bit down or using a dollar-cost-average strategy, the yield could easily top 7%.

Table-1:

Now, let's analyze this portfolio structure in more detail using the Morningstar-Xray feature. Morningstar puts it into a "Moderate" risk portfolio:

Chart-1:

Sector Diversification:

Most sectors are represented in the portfolio, but it is a bit concentrated in Energy and Technology, followed by Utilities.

Chart-1B:

Geographic:

Geographically, it is mostly concentrated in the US and Canada.

Table-2:

Chart-2:

Past Performance and Future Returns:

It is almost impossible to predict how a portfolio will perform exactly in the future, but we can see its past performance, and that can provide some insight. Here is the back-tested performance of our 10-fund portfolio versus the S&P 500 (SP500) and growth of $100,000 from Jan.2007 until the end of Jan.2024.

Chart-3:

Note: For backtesting purposes, JEPI was replaced with EOS (Eaton Vance Enhanced Eqty Inc Fund II). Also, MPLX was replaced by ET (Energy Transfer) for the initial few years.

The 10-fund portfolio performed slightly better than the S&P 500, but the important aspect was the income. If we had started with $1 million in this portfolio as well as the S&P 500 as of Jan.01, 2007, withdrew a starting income of $60,000 a year, and adjusted it for inflation every year, this is how our balances would look:

Note: We replaced midstream partnership MPLX with ET for testing purposes for the sake of longer history.

The Individual Funds (in More Detail):

Fidelity Capital & Income Fund (fa*gIX):

fa*gIX is a mutual fund from Fidelity and falls under the "High-yield" Bond category. Its official benchmark is "ICE BofA US High Yield Constrained Index." However, it is not all bonds but has a history of some decent allocation (roughly 15-20%) to equities as well. The fund has a five-star rating by Morningstar, likely due to its solid long-term performance record. The fund has a long history and has provided an annualized growth of 9.34% since its inception in 1977, which is solid for a bond-centric fund. For the last 3, 5, and 10-year periods, it has returned 4.13%, 6.85%, and 6.18%, respectively, and outperformed its benchmark by at least 2% points for each of the period. It yields roughly 5.26%. It has been managed by the same manager, Mark Notkin, since 2003.

SPDR S&P 500 ETF:

SPY is the most popular ETF to represent the S&P 500 index. The yield is less than 1.40%, and the expense is minuscule. As stated earlier, we are not including SPY for income but to provide market-matching returns and growth.

Invesco QQQ Trust ETF:

QQQ represents the largest 100 companies in the Nasdaq index. The top 100 companies are heavily dominated by technology and other innovation-centric, fast-growing companies. Essentially, we have included it to compensate for any lack of growth from some of our closed-end funds in the portfolio. The dividend yield is very low at 0.55%.

MPLX LP (MPLX):

MPLX is a diversified midstream energy company structured as a master limited partnership. It issues a K-1 tax form (partnership income) instead of the usual 1099 in case of regular dividends.

It was formed in 2012 by Marathon Petroleum Corporation (MPC) for the purpose of owning, operating, acquiring, and developing midstream energy infrastructure assets. To date, MPC remains the largest unitholder of MPLX.

MPLX maintains a solid balance sheet with investor-grade BBB credit rating and pays a very attractive yield, currently at 9.0%. It has paid and raised the dividend payout since its inception in 2012. With a partnership, price appreciation may be limited, but we can expect a very stable and near 9% dividend payout for the foreseeable future.

There are other mid-stream companies that are equally attractive, for example, Energy Transfer LP (ET) and Enterprise Products Partners LP (EPD). However, EPD's yield is a bit lower compared to MPLX and ET.

Liberty All-Star Equity (USA):

This is an equity-based closed-end fund that invests roughly 60% in value stocks and 40% in growth stocks. It uses the 'Lipper Large Cap Core Index" as its benchmark. To some extent, it is akin to investing in the S&P 500 but getting a high yield, obviously at some cost. For most of its history, it has provided returns that trail the S&P 500 by about ½ to 1% points. Since Jan. 1989, it has returned 9.84% annualized (compared to 10.64% from S&P 500). It follows a managed distribution policy based on a formula. It distributes roughly 2.5% of its NAV every quarter as distributions. Due to its variable payout policy, the distribution can vary from quarter to quarter.

Barings Corporate Investors (MCI):

This is one of our favorite funds in the high-yield corporate bond segment. The simple reason is the past performance of the fund. In spite of being a fixed income, it has provided total returns like an equity-focused fund. Also, the fund, incepted in 1971, has seen all kinds of market conditions and upheavals and has performed on a reasonably consistent basis. Although past record is no guarantee of future returns, we see no big reason for any deviation.

Cohen & Steers Infra Fund (UTF):

This is one of the best closed-end funds in the infrastructure segment and comes from the Cohen & Steers fund family. Incepted in March 2004, the fund invests primarily in companies that provide either the basic infrastructure or services in the infrastructure industries, such as utilities, toll-road, railroads, ports, telecommunications, oil and gas pipelines, etc. It is currently providing an 8.45% yield.

Reaves Utility Income Trust (UTG):

This is one of the best quality Utility closed-end funds. It offers consistent and reliable dividends and nearly matches the returns of the S&P 500, though on a long-term basis. A recent couple of years have been tough for most income-focused assets, including utilities. But that is likely to change in 2024 and 2025. Moreover, we get 8% income while we wait for recovery.

Cohen & Steers REIT & Pref. Inc. Fund (RNP):

The real estate sector is one of the best ways to diversify. Owning physical real estate (other than your primary home) is not an easy job for most people. But we have an alternative in the form of REITs (Real-Estate Investment Trusts) or funds that own REITs. This fund from Cohen and Steers is a hybrid fund, though. It invests 50% in real-estate equity and the rest 50% in the preferred securities. Both of these asset classes were hit hard in 2022 and 2023 when the interest rates were rising. However, starting Nov. 2023, when the Fed first hinted about the possibility of rate cuts in 2024, real estate and preferred securities had a nice run. This fund has a very good record in terms of long-term performance and total returns. Besides, it provides nearly 8% yield on a monthly basis as we go.

JPMorgan Equity Premium Inc ETF (JEPI):

JEPI is an income-focused ETF offered by JP Morgan. The fund uses a defensive strategy of investing in large-cap equity stocks with a lower beta (usually .80) than the S&P 500 and combines it by writing the covered calls on the index. It writes monthly covered calls using weekly tranches with OTM (out-of-money) strikes, which allows it to capture a reasonable (but not all) of the upside while earning decent premiums to generate income. The fund uses a rather complex approach of using ELNs (Equity-Linked-Notes) instead of writing actual calls. The ELNs that the fund invests in are derivative instruments that are designed to offer the economic benefits/loss of the covered calls written on the S&P 500 index. Even though we like JEPI, our main concern remains its short history, as it was incepted in May 2020. Since it is designed to invest in lower beta stocks than the S&P 500, it is likely to underperform during bull markets. But it is also designed to offer some protection during a down market. That's why it was down only -3.5% in the year 2022, compared to -18.2% of the S&P 500. But on the flip side, in 2023, it gained only 9.8% vs. 26.1% of the S&P 500.

Another plus point is that by investing in JEPI, we are getting exposure to a large number of high-quality S&P 500 stocks, as only 20% of assets are committed to ELNs. Due to lower beta stocks, JEPI is not as concentrated in the top-10 holdings as the S&P 500 is.

For some of the closed-end funds used above, you can read our recent detailed analysis reports here:

• MCI
• UTF
• UTG
• RNP

Alternative Portfolio with Overall Higher Yield:

Now, our first portfolio, as presented above, yields just under 7%, and that should be sufficient for most income investors and retirees. Definitely, it would vary from person to person, as well as the amount of savings and spending needs a retiree has. The reason this yield is not higher is that we have allocated 10% each to the S&P 500 and QQQ (Nasdaq 100). These two ETFs have very low yields but should provide higher growth over the long term, especially QQQ.

We understand that some folks will need even higher income, and they should have some alternatives to raise the yield level to 8% or 9%. However, please note that nothing comes for free, and it will certainly elevate the risk profile of the portfolio to some extent.

One way to boost this yield would be to start this portfolio a few years (say five years) prior to retirement (withdrawal stage) and re-invest all of the dividends/distributions. That should boost the yield from 7% to 8% - 9%% easily.

However, if you are looking for a higher starting yield right at the beginning of the portfolio, we will need to make certain changes that would elevate the yield.

1) We will replace the mutual fund "fa*gIX" with PIMCO Dynamic Fund (PDI). The closed-end fund is currently providing a very high yield (over 13%). It is going through a rough patch but still has a fair chance to recover. Moreover, it is managed by PIMCO, which gives a certain level of confidence.

2) We will also replace JEPI with another closed-end fund, Tekla World Healthcare Fund (THW). THW is a closed-end fund in the healthcare sector. It is currently providing an 11% yield. The reason we picked up a fund from the healthcare sector is that this sector was under-represented in the first portfolio and obviously for a high yield.

3) We will also replace QQQ with a closed-end fund, Columbia Seligman Premium Technology Growth Fund (STK). As the name suggests, STK invests in high-growth technology stocks but also writes options to generate income. It yields 5.64% currently (a lot more than 0.50% from QQQ) and also provides very high growth.

4) We will replace SPY with Schwab U.S. Dividend Equity ETF (SCHD). SCHD is one of the highly popular dividend ETFs currently yielding 3.45%. It is invested in 104 high-quality dividend-paying stocks, with the top 10 accounting for 42% of the fund's assets.

By making the above changes, we immediately increased the yield by 2% percentage points, taking the total yield to 8.75% with a slightly higher risk profile.

Table-3: Portfolio-2 with nearly 9% Yield

Likely Risks with the Portfolio:

Here are some risks with the above portfolios that the investors should be aware of:

• There is no downside protection. As we can see, during the 2008-2009 financial crisis, this portfolio had a drawdown of roughly 50%, similar to the S&P 500. However, the difference was that a portfolio like this continued to provide roughly the same income during the crisis period. That should make it much easier to ride down any such period.

• Many of the funds may be overvalued at this time. Some of them may be trading at a premium to NAV. One way to mitigate this risk is to buy in multiple installments using the dollar-cost average method.

• The market has priced in the expectations of multiple rate cuts in 2024 and 2005. However, if that somehow does not materialize or gets delayed, some of the funds in this portfolio, especially the ones with leverage and focused on a fixed income, will likely underperform.

• Unexpected situations may arise as the future is always unpredictable, and the portfolio may not perform as we expect.

• Market risk: Obviously, there is a market risk with any such portfolio. If the broader market were to enter into a prolonged downturn, this portfolio would perform in line with the market. In certain situations, it could even perform worse.

Concluding Thoughts:

We normally recommend structuring a portfolio around a three-bucket system and investing in individual stocks. The main advantages that we see in a 3-bucket portfolio are the high growth prospects, no ongoing fees, a reasonable level of income (roughly 5%), and an in-built hedging mechanism to limit the downside risks. However, many readers find it a bit complex.

That's why, in the article above, we have outlined a very simple and straightforward portfolio of 10 funds (including ETFs, Closed-end funds aka CEFs, and a mutual fund). The biggest USP of this portfolio would be its simplicity and very little maintenance. In spite of its simplicity, this portfolio will generate nearly 7% income, aim for decent growth, and likely provide 10% total returns over the long haul.