In my previous article, I talked about what assets can generate income for you. This time, I will talk about the next logical question: How can I create and construct an investment portfolio of income generating assets?

There is a simple process for that. In investment management, we use a set of principles as a guide for constructing a client’s investment portfolio. We look at the HERO: Horizon, Experience (of the investor), Risk appetite, and investment Objectives.

For example, you want to have your investment portfolio augment the expected spending for your children’s education. You expect to be spending for their education for the next 10 years. With your PHP 10-million savings, you need it to provide PHP 500,000/year to augment education expenses without drawing from the PHP 10-million capital.

This translates to 5% per year for the next 10 years. You may have several options. For example, the 10-year government bond yield is 6.22%, subject to a 20% withholding tax. There are dividend paying stocks that give a dividend yield of 7.0% per annum.

So the objective is to have the investment portfolio provide PHP 500,000/year or 5% per year over the next 10 years. There is also an additional objective to keep the capital intact after the 10 years.

If you have the appetite for risk, a combination of fixed income and equities is possible. If you can’t deal with the possible loss or price volatility, you may have to limit your investment options to bonds and time deposits.

The next thing to consider is your experience (as an investor). If you have a good understanding and experience of investing in direct securities (bonds and equities) as well as in pooled funds, you will have more investment options. If you don’t, however, pooled funds such as unit investment trust funds (UITFs) and mutual funds that pay dividend income can be good choices.

So now you have your horizon (10 years), experience (let’s assume you have invested in many types of assets), risk appetite (let’s assume you are aggressive), and objectives (5% per year).

Choosing the right assets

Given this information, the assets we can consider for the portfolio are cash, time deposits, bonds, and equities since your tolerance for risk is high and you have experience in investing in these types of assets.

Bonds and equities are needed to reach the target investment yield of 5% per year in net return, while time deposits are liquid financial instruments.

If you invest your PHP 10 million in a 10-year bond with a gross yield of 6.22%, this will give you a 4.98% net yield (due to the 20% withholding tax), which is very close to the 5% target net yield.

The resulting income stream is PHP 498,000 a year, just PHP 2,000 short of the target. The upside is that the income is fixed and very likely to be received.

Alternatively, the portfolio can be a mix of bonds and dividend-paying stocks. You may, for example, allocate 90% to the 10-year bond with a 6.22% gross yield, and 10% to dividend-paying stocks with a 7% dividend yield.

The weighted payout yield would be 5.11% (net of withholding tax for interest and dividend income). This portfolio mix will provide sufficient income for the education expenses, with an expected income cash flow of PHP 511,000 per year.

However, there is a risk of a shortfall if no cash dividend is declared in certain years. This is why it is important to carefully choose the companies by selecting those that are likely to pay consistent dividends.

Usually, blue-chip companies such as utility companies have a steady source of income, which, in turn, can pay regular dividends to their investors. You just have to do your research or seek advice from your investment counselor, if you have one.

Look for the big picture

In investment planning, there are several investment strategies employed to achieve a particular set of financial objectives, depending on the life stage and financial needs of a person.

A young investor with a long-term investment horizon would have an investment objective of high growth. He will want long-term returns during the wealth accumulation phase. Meanwhile, a pre-retiree may have an investment objective of having his savings and investments provide a steady income for living expenses.

To ensure one’s financial success, we need to have the HERO checklist to come up with appropriate investment strategies given the life stage, investment horizon, one’s experience, risk appetite, and investment objective.

This is a dynamic process that needs to be reviewed periodically or when an important event in life happens.

So before you invest in anything, I advise you to consult a professional investment manager or advisor. With an impartial professional giving you advice, you increase your chances of reaching your investment goals.

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DEXTER AGCAOILI is the Retail Propositions Director for Single Premium Products and Unit Linked Funds Category at AXA Philippines. He has a solid background in finance, investment management, and governance, having held leadership positions in the financial industry. He has also taught at De La Salle University and the University of the Philippines Business School and served as a lecturer for certification programs like the PSE Certified Securities Specialist course and CFA Philippines. Dexter earned his business economics degree and master’s degree in finance from the University of the Philippines. His hobbies include collecting timepieces, and part of family time is traveling and playing Cash Flow 101 with his two daughters.