The BlackRock income portfolio strategy is a diversified 100% bond basket that seeks to provide a steady stream of cash income while minimizing potential loss of capital and stock market volatility. Participants can choose from four risk levels, each with different targeted levels of income yield. The tradeoff for higher expected income is greater risk.
Why the Income Portfolio Might be a Good Fit for Your Participants
Often, participants value stable income and principal preservation during the later stages of their lives. The income portfolio strategy can help plan participants preserve their nest egg after they retire or if they’re nervous about investing in stocks while they’re still working.
The chart below shows the expected income yields for each of the four risk levels in the income portfolio strategy and how those levels compare to the Betterment portfolio strategy with similar levels of risk.
Disclosure: This chart compares the four BlackRock income portfolios available to Betterment against four allocations of Betterment’s core portfolio strategy with similar relative risk levels. All four of the comparison allocations include both stocks and bonds, while BlackRock’s income portfolios are comprised completely of bonds. The Betterment Portfolio’s income yield is comprised of dividends from equities and coupon income from the underlying bonds in the fixed income ETF. The BlackRock Target Income Portfolios’ income yield is comprised solely of coupon income from the underlying bonds in the fixed income ETF.
The expected income yields are expressed in annual terms and are based on the historical dividend yields over the past 1-year period ending August 30, 2017 for the individual funds in each of the portfolios, as reported by Yahoo Finance. These expected yields correspond to the time period referenced above for the funds in the relevant portfolios and will change over time as economic and market conditions change. When an economy is expanding (contracting), for example, interest rates will tend to rise (fall) and credit markets will tend to strengthen (weaken) as companies become less (more) vulnerable to defaulting on their debt.
These figures do not include the Betterment fee or fund level expenses. The Betterment stock allocations shown here correspond to the Betterment portfolios that have expected volatilities that are closest to the expected volatilities of the four BlackRock income portfolios. The stock-to-bond allocations used for Betterment are: 9% stock to 91% bond, 22% stock to 78% bond, 37% stock to 63% bond and 40% stock to 60% bond. Expected volatilities are estimated based on the historical total returns data for the relevant funds over the past 10 years using the methods of Ledoit and Wolf (2003). This chart is hypothetical and used to illustrate the points discussed in this article. Past performance is not indicative of future results and does not guarantee that any particular result will be achieved.
As you can see, BlackRock’s income portfolios have a higher expected income yield than allocations in Betterment’s core portfolio strategy with comparable risk levels.
For example, if a participant in your plan had $1,000,000 in savings in their 401(k) account, she could invest it in the 40% stock Betterment portfolio, and the income portion of their return would be about $24,000 per year in gross investment income. (Note that the income portion composes only part of the total potential return generated by a Betterment portfolio allocation.)
But remember, investments generate returns in two ways; income and principal growth. We refer to these two forms of growth as the total return of an investment. Bonds can provide steady income but historically have provided lower principal growth than have stocks. For this reason, putting some money in both the income strategy and the Betterment portfolio strategy may be a preferable alternative for some investors.
Retirees who are interested in the income portfolio strategy can pair it with Betterment’s automatic withdrawal feature to set their retirement income on autopilot.
Less Historical Risk
For participants who are nervous about investing their retirement fund in stocks, the income portfolio strategy can be a good approach because the underlying bonds have a lower historical risk than stocks. According to Gallup, 48% of Americans have no money invested in the stock market. And with the best savings accounts paying only slightly above 1% in interest, keeping too much money in cash means your money loses value to inflation every day. Choosing bonds over cash can be a nice middle ground that better balances risk and return.
The chart below shows the risk (as measured by standard deviation) for various types of bonds over the past 15 years, compared to stocks in large US companies.
The chart shows the risk (as measured by standard deviation) for various types of bonds over the past 15 years, compared to stocks in large U.S. companies. Click respective categories for data on short-term bonds, intermediate-term bonds, long-term bonds, high-yield bonds and large cap stocks.
Short-term bonds were almost six times less risky than US large company stocks. Even high-yield bonds, the most risky type of bonds, were almost two times less risky than stocks.
It’s worth noting that investing in bonds is generally more costly than investing in stocks, so plan participants will pay a higher expense ratio on income portfolio funds compared to funds invested in the core Betterment portfolio. The Betterment portfolio strategy, which contains a mix of stocks and bonds, has annual ETF fees of only 0.07% – 0.16%, depending on the portfolio’s allocation. Our income portfolio strategy, while still far lower cost than the industry average, has slightly higher ETF fees of 0.21% – 0.38%, depending on the portfolio’s target income level.
Different Income Targets to Meet Participants’ Needs
The strength of Betterment for Business’ approach is that all of our portfolio strategies can adjust to your participants’ risk tolerance. The income portfolio strategy is no different. We selected BlackRock’s iShares™ ETFs to invest in different types of US and international bonds including US Treasuries, mortgage-backed securities, corporate, high-yield, and emerging market bonds.
We had no incentive to partner with BlackRock other than the strength of their fixed income expertise and the robust construction of the iShares™ ETFs.
To align with each participant’s risk preferences, we offer four different risk levels to choose from, each with different targeted levels of income. The income portfolio strategy is actively managed, so the exact allocations of the underlying bonds are subject to change approximately once per quarter (and up to six times per year depending on market volatility). With each rebalance, we allocate to the asset classes that are designed to help investors maximize the income return while limiting overall volatility.
Risk and return are connected, so lower-risk bonds pay less income than higher-risk bonds. The income portfolio increases projected income by taking on more risk in two main ways:
- Investing in longer-term bonds: Long-term bonds are more sensitive to changes in interest rates, and thus carry more risk. To compensate for this risk, long-term bonds pay more interest.
- Investing in lower-quality bonds: When you lend money to less-established companies, the chances of the company defaulting and not paying you back are higher. To compensate for this risk, low-quality bonds pay more interest.
We are proud to offer an income portfolio strategy for Betterment for Business because, with more strategies like this one, 401(k) plan participants can personalize their investments to match their specific retirement timeline, risk tolerances, and viewpoints.
To get started, participants can open a new goal account and select the BlackRock income portfolio strategy.