ISO reliable yield in today's high-rate environment

No matter what the market environment, positive portfolio outcomes generally rely on a client's spending habits combined with thoughtful asset allocation that matches both a client's needs and risk appetite. 

But particularly in today's high-rate environment, providing clients with a reliable income stream is a vital component of a well-rounded portfolio, one that can help with planning, contribute to wealth accumulation, help protect against inflation, aid in risk management and ensure income stability during retirement while freeing clients to embrace other investments. 

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The key is to focus on securities that add income prudently by taking into account equity styles, credit and duration while avoiding the risks of "high yield" investments, the worst of which is permanent loss of capital.

The goal is to produce reliable yield. Here are some considerations and risks to take into account when planning for portfolio income in the current high-rate environment. 

Longevity risk
The rise in interest rates means that clients with sufficient means to spend within the commonly used 3% to 4% withdrawal rate have the potential to live solely off of fixed income coupons. That said, locking a client into fixed cash flows now puts them at risk of losing purchasing power over time if inflation continues. Thoughtful planners know to pursue a mix of investments that can not only distribute income, but also provide growth potential to keep up with inflation and taxes.

READ MORE: Reimagining fixed income investing with YieldX CEO Adam Green

Capital risk
The S&P 500 yields roughly 1.5%. While we love owning companies that can safely pay and grow dividends, stocks have risen to a level where the income from owning quality dividend-payers falls short of typical withdrawal rates — meaning it's less than the commonly used 4% withdrawal rule amount made popular by Bill Bengen. In reaching for yield beyond financially sound companies, investors are taking the risk of getting sufficient income but losing principal. Not the ideal path.

Growth risk
Between 1900 and 2022, total stock market returns were generated by roughly one-third dividends and two-thirds growth, with valuation sometimes helping and sometimes hurting. If the current dividend yield of 1.5% contributes its historical one-third, that adds up to either less than 5% total returns or heavy reliance on growth and/or increased valuations. 

Given this, it's more important than ever to know what types of risks we're taking in pursuit of meeting clients' spending needs. This is where equities come into play. While a portion of a portfolio can focus on distributable income, a sensible plan includes additional sources of return — ideally, ones that can grow alongside inflation. Disinflation was great from the 1980s into the 2020s, but we've been reenlightened on the impact of rising costs, especially for those clients on a fixed income.

READ MORE: How to avoid the dividend stock 'yield trap'

While growth may not be the primary goal for many retirees, its role in inflation protection can't be ignored. Over time, it's likely that rising prices mean today's $100,000 budget eventually sneaks toward $200,000; an income-only approach will increasingly eat into savings. 

Given this, a combination of income and growth makes the most sense (as indeed it always does) — especially for those in retirement or entering it soon. The yield portion can be used toward spending needs, and if thoughtfully pursued, can unleash the rest of the portfolio to at least keep up with inflation and hopefully surpass it.

Beyond that, real estate investment for income, whether through direct ownership or aggregated through public or private REITs is worth a look, as is private credit and bank-sponsored structured notes. Alternative income opportunities in interval funds and structured notes are now accessible inside of ETFs to retail investors. These products require additional due diligence but often provide competitive yields in a liquid wrapper. 

Derek Hernquist, the head of advisor experience at Aptus Capital, contributed to this article.