**In retirement, what allocation percentage would you recommend between high-yield holdings (for immediate income) vs. dividend growth stocks to keep up with inflation? **

**Capital preservation and inflation-beating income is the goal.**

This is a very interesting question. It’s often considered to maximize retirement income or in situations where the portfolio is just not as big as it should be.

## Yield Categorization

Before I provide my thoughts, we need to categorize yield. Here is how I approach it.

- Over 6% is a risky yield (unless there is a market crash) or it comes from advanced investing instruments (think covered calls)
- Between 4% and 6% is high yield (company has consistent excess cash)
- Between 2% and 4% is normal yield
- Under 2% is low yield with higher stock growth

The reader asking about high yield was looking for a yield between 5.5% to 7%. That’s a risky yield if you follow my guidelines above. Sure, some products offer those yields, but there is always a yang to the yin. More on that later.

There is a statistical norm to yield, and there is a reason why it’s risky for a corporation to pay over 6% consistently year after year. Paying a very high yield puts a lot of pressure on a company to maintain it. That’s why you won’t find many, and those that do will often have no growth or inconsistent distributions.

Usually, companies will have a lower sustainable yield, and if there is excess cash, they initiate a share buy-back program. Both are good for investors, but they send different signals.

## The Ground Rules

In order to outline the ratios, it’s essential to know where you stand with a 4% income rate. Since 4% is often used as a withdrawal rate, I will use 4% as an income yield for retirement.

Here is a table showing the numbers you should have. Those are gross numbers, and I will leave you to do your taxes.

Yield | Annual Gross Income | Total Portfolio |

4.0% | $40,000 | $1,000,000 |

4.0% | $48,000 | $1,200,000 |

4.0% | $56,000 | $1,400,000 |

4.0% | $64,000 | $1,600,000 |

4.0% | $72,000 | $1,800,000 |

When you consider the above and are close to retirement, you have two variables in your control: the yield and the portfolio value. However, growing the portfolio value by hundreds of thousands is not easy and is often out of reach.

As such, investors often want to increase the yield to increase the annual income. Say you push it up to 5.0%; you get the following income, which makes a difference.

Yield | Annual Gross Income | Total Portfolio |

5.0% | $50,000 | $1,000,000 |

5.0% | $60,000 | $1,200,000 |

5.0% | $70,000 | $1,400,000 |

5.0% | $80,000 | $1,600,000 |

5.0% | $90,000 | $1,800,000 |

## Ratio Strategy

First, ignore the companies and focus on the math since it’s a math problem. Consider the options below as a guide to build a solid retirement plan.

We break down the ratios by the four groups we identified above and start doing math with a $1,400,000 portfolio we can use below as a safe start.

Portfolio Ratio | Amount | Assumed Yield | Annual Income | |

Risky Yield | 5% | $70,000 | 7.0% | $4,900 |

High Yield | 20% | $280,000 | 5.0% | $14,000 |

Normal Yield | 60% | $840,000 | 3.5% | $29,400 |

Low Yield | 15% | $210,000 | 1.5% | $3,150 |

$1,400,000 | 3.68% | $51,450 |

I assume this is not the income you expected. Let’s tune it to a 4% total yield without risks.

Portfolio Ratio | Amount | Assumed Yield | Annual Income | |

Risky Yield | 5% | $70,000 | 7.0% | $4,900 |

High Yield | 30% | $420,000 | 5.0% | $14,000 |

Normal Yield | 60% | $840,000 | 3.5% | $29,400 |

Low Yield | 5% | $70,000 | 1.5% | $3,150 |

$1,400,000 | 4.03% | $56,350 |

I know what you are thinking: With a portfolio this size, why can’t I generate more? Let’s be a bit more aggressive now and limit capital growth in favour of income.

Portfolio Ratio | Amount | Assumed Yield | Annual Income | |

Risky Yield | 10% | $140,000 | 7.0% | $9,800 |

High Yield | 45% | $630,000 | 5.0% | $31,500 |

Normal Yield | 45% | $630,000 | 3.5% | $22,050 |

Low Yield | 0% | $0 | 1.5% | $0 |

$1,400,000 | 4.53% | $63,350 |

As you can see, the exercise does not discuss investments. We are simply doing math with assumed numbers. The above table has an aggressive holdings ratio, as there is a risk implied as you move your ratio towards risky yield.

Assuming this portfolio ratio is what we want, where normal-yield stocks will provide the dividend growth to keep up with inflation, we are left with increasing the yield for normal and high-yield stocks. Instead of 3.5%, we target 4.0%, and instead of 5.0%, we target 5.5%. The simple tuneup brings your yield close to 5.0% overall.

Portfolio Ratio | Amount | Assumed Yield | Annual Income | |

Risky Yield | 10% | $140,000 | 7.0% | $9,800 |

High Yield | 45% | $630,000 | 5.5% | $34,650 |

Normal Yield | 45% | $630,000 | 4.0% | $25,200 |

Low Yield | 0% | $0 | 1.5% | $0 |

$1,400,000 | 4.98% | $69,650 |

Are you satisfied with the number now? I feel we reached the optimal ratio with minimal risk of sleeping at night. If you push higher, you end up with riskier holdings. This is why my retirement number needs a bigger portfolio.

The above are all hypothetical, and the reality will differ, but you can use the format to consider your portfolio construction.

Now you have parameters for your screeners. Remember that normal yield stocks should have some dividend growth to beat inflation over time. Your income has to grow annually.

## Pushing Your Income Higher

Most companies rarely reach the high yield, and to reach the risky yield, you will need to consider options and look into covered call ETFs or specialty funds such as Canoe EIT Income Fund.

For example, ZWB is a covered call ETF that follows the banks and will provide a higher yield than the banks. However, your taxes can get more complicated by tracking the Return of Capital from distribution, but you gain an extra 2% to 3% of income. Many alternative investment options also pay monthly, and income seekers greatly appreciate this.

You do not lose the Dividend Tax credit or Dividend Growth with the covered call ETF’s such as ZWB. For example, ZWB distributions are favourably taxed about 50/50 Eligible Dividends/ROC-Capital Gains.

Any Div growth would be factored into the distribution.

Nice. Thanks for confirming this.

Geez, even with 30 plus years of DIY investing this is waaaaay too confusing for me to grasp.

You would probably find a plan from an advisor very confusing since they would put a few like this in front of you.

With that said, I am not sure how to simplifying it unfortunately.

What many investors do is actually break the yield type by accounts where a TFSA will hold certain stocks vs RRSP and non-registered accounts but it doesn’t always reflect the proper ratio needed for the desired income.

Converting an RRSP, where many Canadians have their retirement savings, to a RRIF is even more complicated because the government provides a schedule of percentage withdrawals from your RRIF. I believe that at the age of 65 your minimum annual withdrawal is 4%. However, by the age of 71 your minimum annual withdrawal becomes 5.28%. Therefore, over time, it becomes more and more difficult to replace the required income without depleting more and more of your RRIF.

You are indeed correct. The account and taxes start comlicating withdrawal even if you have the income ratios you want.

RRSP/RRIF withdrawals are definitely a different question which is very complicated as it’s based the very personal situation of everyone.

The tax man will get its money.

I have a $300k RRSP and a lump sum of $700k (sold my rental). 8 years until CPP/OAS as a 70 year old.

My plan is to deplete my RRSP over the next 8 years. Why? Because I am taxed at FULL VALUE when I withdraw from my RRSP, but my $600k lump can grow at only 50% tax rate on the dividends (and not the capital increase which will get taxed at 50% as I liquidate holdings over time). When my RRSP is depleted, CPP/OAS will take over and I can shift to pulling out 4% from my lump investment. The $600k, over the next 8 years, should double between dividends and general increase in value.

That keeps me at a 4% withdrawal rate overall and according to Monte Carlo simulations should result in a 99% chance to retain my capital over the long term.

My situation is more nuanced than the scenario above: obviously I can’t live on $30k a year but the broad strokes are there.

Open to opinions.

Michael

Withdrawal strategies are definitely not a one size fit all. It becomes a tax strategy as you point out :)

I think more content on how to structure a retirement, based on income derived from dividends / distributions, focussed on this notion of asset risk / return would be invaluable.

I have always viewed investments like EIT, DFN (you know the list) as undesirable because of their inability to raise their dividend over time, and the common depreciation of the original investment.

On the other hand, I have come to accept the common notion of three phases of retirement – “go-go”, “slow-go” and “no-go” and the associated implications that you need more money for the first, less for the second, and even less from the third (especially if you maintain an unleveraged primary asset to utilize as a resource later on).

So, with that in mind, I might be okay with using some EIT / DFN for those “go-go” years so that I’m intentionally “juicing” the earlier part of retirement knowing that the later years I won’t necessarily need to track inflation perfectly (or at all) because my needs will reduce over time also.

Thoughts?

You are correct. EIT and DFN along with Covered Call ETFs are options for higher income but you still need to find a way to keep up with inflation.

The inflation question, is really based on what you need from day-to-day. Not having an increasing yield in the second or third year might not be noticeable but after 5 or 10 years it will.

It’s hard to write on depletion without knowing if the person start with more or less than needed and at what age they start such as 50, 55, or 65?

If you want to increase your 10% of “risky yield”, do so knowing what you get into as the options you mentioned are good options.

The corp income project will show how I will be approaching generating income.

Excellent. Thanks.

This was a great article. Very clear to me because I have a mathematical mind, but not a particularly analytical one. Gave me much to think about. Thanks,

Really glad it was useful. Income from a portfolio is a simple math problem even before you have to select your investments :)