4 Asset Classes for Every Retirement Portfolio

We all knew that the Fed’s quantitative easing programs wouldn’t last forever, yet when the Fed first started to discuss the possibility of tapering in May, it took the market by surprise.

As a result, income investments had a less-than-spectacular summer. The price of the 10-year Treasury note slid by more than 12%, and the prices of “bond substitutes” such as utilities and certain classes of REITs fell by significantly more.

It’s frustrating to see a decade’s worth of income disappear in a matter of two months due to capital losses. And the prices of income-paying investments will probably stay volatile until the Fed clarifies its intentions on quantitative easing.

We might get some concrete guidance from Bernanke as soon as this month. But regardless of what the Fed does, we all have retirements to plan for. Today, I’m going to look at four asset classes that all investors need in their retirement portfolios.

Dividend Stocks

Dividend stocks have become almost trendy in recent years, and it’s easy enough to see why. Two major bear markets in less than a decade destroyed the cult of equities and the belief that, given a decent time horizon, stock prices “always” go up.

Regardless of whether prices “always” go up, you still need income to pay your bills. And dividend stocks can be a big contributor to that income.

There are two basic approaches you take here. You can go for stocks with high yields, such as utilities and slower-growth consumer staples. Or, you can focus on stocks with a modest current yield but a high dividend growth rate. For a stock you intend to hold for a while, the high-growth stock can eventually give you a higher yield on cost than the current high yields.

I wrote a short piece in July that broke down the numbers for some of my favorite income stocks. In 2003, Johnson & Johnson (JNJ) and Walmart (WMT) yielded 1.5% and 0.65% in dividends, respectively. A million dollars invested in each would have paid out $15,296 and $6,538. That stacks up pretty poorly in comparison to the $40,000 you could have received in bond interest by investing in Treasuries.

But let’s fast-forward 10 years. Those original million-dollar investments in Johnson & Johnson and Walmart would be paying you $49,244 and $34,144, respectively, in 2013. Walmart’s total cash payout is still a little lower than the payout from the Treasury note, though it rose by more than a factor of 5 — and will likely keep rising at a blistering pace for the foreseeable future.

Bottom line: You need dividend growth stocks in your retirement portfolio. For a nice “fishing pond” of potential buys, check out the holdings of the Vanguard Dividend Appreciation ETF (VIG). Every holding has raised its dividend for a minimum of 10 consecutive years. Also, InvestorPlace’s Dependable Dividend Stocks have each improved their dividends for a minimum of 25 years.

Master Limited Partnerships

Along the same lines as dividend-paying stocks, we have master limited partnerships. MLPs are operating businesses that tend to be concentrated in the oil and gas sector. Like dividend-paying stocks, a large chunk of their total returns come from their cash distributions, but because MLPs are organized as partnerships rather than corporations, they avoid paying federal corporate income taxes.

In nutshell, this means they have 35% more cash at their disposal to distribute. And because many MLPs have large non-cash expenses, such as depreciation, those distributions often end up being tax-free for years at a time. Not bad.

A lot of investors are intimidated by MLPs, and they shouldn’t be. Yes, come tax time, you have to deal with a pesky K-1 form, and no, you can’t hold most MLPs in an IRA account without creating a potential tax nightmare. But most K-1 forms can be uploaded to mainstream tax programs like TurboTax, and if your CPA gripes about them or tries to charge you more to do your taxes … well, perhaps it’s time to find a new CPA.

And as for holding them in a non-IRA account, it’s hardly much of an administrative burden to open a regular brokerage account if you don’t have one.

If you’re bound and determined to hold MLPs in an IRA account, or if you are investing only a modest sum, you could always buy an MLP mutual fund or ETF product, such as the JPMorgan Alerian MLP ETN (AMJ). I use this security in client IRA accounts I manage. But where possible, I prefer to avoid the hefty 0.85% expense ratio and enjoy the favorable tax treatment of holding individual MLPs.


Next on the list are real estate investment trusts. Like MLPs, REITs are special entities that get preferential tax treatment. REITs avoid corporate-level taxation if they distribute at least 90% of their earnings. The dividends are taxable, and REITs can be held in an IRA account with no tax complications.

There are two types of REITs — mortgage REITs, which buy mortgage securities and related derivatives, and equity REITS, which buy real property ranging from apartments to warehouses and everything in between. I currently invest in both, but for long-term retirement funds I limit myself to equity REITs. Because of their high sensitivity to interest rates movements, I consider mortgage REITs highly speculative and appropriate only for more aggressive strategies.

What makes real estate such an excellent retirement holding? To start, it has a built-in inflation hedge. Assuming they are purchased at reasonable prices and in stable locations, a diversified portfolio of properties should, at a minimum, see their values rise with the overall price level. The same is true of rental income — it’s not often that landlords lower your rent.

Although I use them in certain ETF-only accounts I manage, I’m not the biggest fan of REIT ETFs because they tend to overweight a small handful of REITs that I do not consider particularly attractive.

Where possible, I prefer to buy individual REITs. And in long-term retirement accounts, I’m particularly fond of REITs that specialize in free-standing triple-net-lease properties — things like grocery stores and pharmacies. Two that I own personally — and hope to own for the rest of my life — are Realty Income (O) and National Retail Properties (NNN). Both have a long history of raising their dividends, and both skated through the 2008 meltdown with relatively minor scratches.


I hate bonds. I really do. They are most vulnerable to higher-than-expected inflation, and they offer no opportunity for growth. Unless you intend to actively trade it, the yield you secure when you buy the bond is the yield you will get for its entire life.

But this stability is precisely what makes bonds a necessary evil, even in a low-yield world. Bonds play the role of portfolio stabilizer, and they can be used in a dynamic rebalancing strategy.

What do I mean by this? Let’s say your portfolio’s target allocation to bonds is 40% (That’s too high for my liking, but it’s considered the industry standard). If the stock market takes a short-term nosedive, you can sell off a portion your bonds and use the proceeds to buy stocks and rebalance. Likewise, if the market goes on a massive bull run, you can sell off some of your appreciated stock and buy bonds. The result is that you are constantly buying low and selling high.

Of course, this strategy works a lot better when bonds pay a respectable yield. Even after the recent taper scare, the 10-year Treasury still yields less than 3%.

My advice? If you need bonds as a portfolio stabilizer, buy individual bonds if possible and not bond funds. Bond funds are assumed to be perpetual, and returns will be terrible in a prolonged period of rising rates. But an individual bond held to maturity has no interest rate risk.

Also, try to stay shorter-term on the yield curve. If you believe yields are going higher, a bond with a shorter maturity will give you the opportunity to reinvest sooner and at a higher rate.

This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is the editor of the Sizemore Investment Letter and the chief investment officer of investments firm Sizemore Capital Management. As of this writing, he was long AMJ, JNJ, NNN, O, VIG and WMT. Click here to learn about his top 5 global investing trends and get your copy of “The Top 5 Million Dollar Trends of 2013.”

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