Transcription
I'm going to give one of the most popular income investments a flat F and hand the highest grade to one most advisors have never ever pitched you. I'm Christopher Nelson. I run a micro family office and my income portfolio generates around $200,000 a year in tax-efficient income.
In this video, I'm ranking every income investment from best to worst. But fair warning, this ranking is built for one specific investor. And if that's not you, some of these grades are going to look flat wrong. And remember, this is not investing advice.
So, let's get specific about that investor because the details drive every grade. Our example investor has $5 million in investable assets. They're 5 years out from depending on their portfolio for income and the part that changes everything, they've done private investments. So, sponsors, lockups, capital calls, and K-1s aren't scary words, they're part of their experience.
Here are the five things that drive the grading criteria. What yield does it generate? How liquid is it? How tax-efficient is the income? What do the fees cost you? And for anything private, how strong is the track record of the operator running it? The grades run S through F. S is the highest fit for this investor. F means avoid. Let's go rank them.
First up, annuities. Someone has probably pitched you one. Technically, annuities are income vehicles. They can work in very specific longevity scenarios and I know people who genuinely like them. But the fee structures are often opaque and yields rarely compete with the other options on the list today. The complexity isn't worth what you give up in flexibility and yield. And for somebody building a real income engine, you have far better options. So, annuity is getting F for our investor.
Next, high-yield savings, money market, and T-bills. These are paying 3 to 4.5% right now with zero risk and full liquidity. T-bills get a bonus. The interest is exempt from state and local taxes. Safe, accessible, essentially is dry powder. 5 years out, you still want a solid cash flow here. You don't need to over park, enough to fund private capital calls, take advantage of dislocations, and avoid ever being a forced seller. The grade? A B.
Next up, covered call ETFs. A covered call ETF holds a basket of stocks like the S&P 500, and sells call options against those positions. The option premiums create income on top of the dividends, often 8 to 15% yield, sometimes 20% and above. The yield is dramatically higher than dividend ETFs, but you miss out on some appreciation potential since you're capped at the strike price of the option sold. And these trade on public markets, so they're fully liquid. A quick note on tax. Some covered call ETFs use index options that qualify for 60/40 tax treatment under section 1256, which can be more favorable than ordinary income. The exact profile depends on the specific ETF. For our person, this is an S. Running it through the criteria, yield is high, liquidity is full, the index option version gets the 60/40 tax treatment under section 1256, so the income is tax efficient, not just abundant. There's no operator to underwrite, and fees on the major funds are reasonable. High yield you can actually keep with daily liquidity. That earns an S. And if you want to understand the mechanism of covered call ETFs, I made a video diving deep into how they work. I'll link it in the description at the end of this video.
Now, let's move to dividend aristocrat stocks. I give these an A. These are individual blue chip companies with 25-plus year track record of consecutive dividend increases. Yields run anywhere from two to four, possibly 6%. Most of these dividends are qualified, meaning they're taxed at long-term capital gains rates rather than ordinary income. So, why an A and not an S? Well, concentration risk and yield. Owning individual companies means more concentration than a diversified ETF, and the yield, while reliable, is modest when you could be putting higher-yielding private vehicles to work. This is the bedrock, reliable, tax-efficient, fully liquid foundation, not workhorse.
Now, next is one you've probably heard of or maybe done, real estate syndications. Syndications are private investments where a sponsor acquires a property, raises capital from accredited investors, and operates on their behalf. Cash yields can be anything from 4 to 6 to 6 to 10%. Those are normal, plus a share of appreciation at sale. For somebody with private market experience, this is where the grade moves up quickly. The three-to-seven-year lockup that breaks a near retiree isn't the threat it looks like. In an evergreen model, you're holding for the cash flow, not waiting for the exit. And you've already developed that skill that protects you here, evaluating sponsors, track records, alignment, communication during downturns, how they handled the last bad investment. The single asset risk is real, which is why this isn't an S. You spread it by building a portfolio of syndications across operators, geographies, and property types. Done that way, syndications get an A.
Now, REITs, real estate investment trusts, I give these a C. REITs are how you get real estate exposure without owning property. Yields run 4 to 8%, they trade on public exchanges, so you have full liquidity. REITs are required to distribute at least 90% of taxable income, which supports higher payouts, but most distributions are taxed as ordinary income rather than qualified dividends. Account placement matters. REITs work well in tax-advantaged accounts like IRA, less well in taxable accounts at higher tax brackets. So, for our persona, the knock is the tax treatment. Most REIT distributions are taxed as ordinary income, not qualified dividends. So, in a high bracket, the after-tax yield shrinks fast. You're getting real estate exposure in its least tax efficient wrapper. Useful inside of a tax-advantaged account, mediocre in a taxable one, that nets out to a C.
High yield dividend ETFs. Now, back to equity income and a grade higher than REITs, high yield dividend ETFs earn an A. These are similar to dividend growth ETFs, but optimized for current yield rather than dividend growth. The companies inside may not have the 25-year track records, but they're paying more today. Slightly more volatility, but more income and still fully liquid, useful complement to your private side income vehicles.
Now, private credit and hard money lending, this is where the upgrade is the biggest. This is direct lending outside of the banking system where accredited investors access yields that don't exist in public markets. You're looking at 10 to 15% from real loans being repaid. For someone new to private investment markets, I grade this a D because the capital lockup plus the credit and operator due diligence required is too much to take on without repetitions. For our persona, it flips because they already understand how to evaluate a fund manager, and here operator selection is everything. The yield is structurally higher than anything liquid. The lockup is survivable because you're holding for income, not the exit. And the returns are uncorrelated with the stock market, diversification that you can't get on the public side. So, why an A and not an S? Most of the income is interest taxed at ordinary rates, the least efficient bucket there is. Now, if you built up depreciation from your real estate to offset it, that changes the math and with this it earns every bit of the grade. Without that shelter, the after-tax yield is what keeps it off the top tier. This is not a position to dabble in. You concentrate your time on a small number of high conviction managers, you spread allocation across them, you let it compound. Private credit gets an A.
Tax-efficient bonds, here on the simpler end of fixed income, tax-efficient bonds land a B. High-quality municipal bonds today often yield 3 to 5% federally tax-free. In many cases, state tax-free if you buy bonds issued in your own state. For someone in the 37% tax bracket, a 4% muni yield is roughly equivalent to a 6.3% taxable yield. Some newer bond strategies layer in covered calls to push combined yields to 5 to 6% with a tax-efficient mix. Reliable, tax-advantaged, liquid. The watch-out is interest rate sensitivity. Bond prices move when rates move, but this is a solid B.
Next up is a step up in complexity from bonds, MLPs or master limited partnerships. MLPs are primarily energy infrastructure businesses, pipeline, storage, processing, structured as paths through partnerships. Yields run 5 to 8% with exchange-traded liquidity and often tax-advantaged distributions. I give those a B. On tax efficiency, they scored well. A large share of the distribution is return of capital, which defers tax until you sell. The K-1 reporting isn't a barrier for somebody who already files K-1s from existing private deals. The watch-out, held inside of an IRA, MLPs can trigger UBTI, unrelated business taxable income, which creates tax issues in accounts that are supposed to be tax deferred. So, why a B and not higher? Well, you buy these on the open market like a stock, less direct control, and because they're public and efficiently priced, there's no asymmetric return to capture the way there is in the private deal. Tax efficient income, but you're a price taker, that's a B.
Dividend growth ETFs, back to straightforward equity income. Dividend growth ETFs earn an A. These hold companies with long histories of paying and increasing dividends. Yields are modest 2 to 4%, but the focus is on consistent dividend growth across recessions and market stocks. Many of these dividends are qualified, so they're taxed at lower long-term capital gain rates for most investors. Diversified, fully liquid, easy to understand, solid A.
Now, let's move into private equity real estate funds. Unlike syndications, these funds are diversified across a portfolio of properties or real estate loans rather than a single investment. More diversification than a syndication, less liquidity than a REIT. Some have quarterly liquidity windows, others can lock up for years. Cash yield often runs 4 to 8% once the fund is fully invested with total return targets in the mid single to low double digits. For our persona, this gets an S. Run the criteria. The diversification across many properties kills the single asset risk you carry in syndications. The underlying real estate throws off depreciation, so a meaningful share of the cash yield can come back tax advantaged. And on operator risk, this is where you lean on funds with long public track records across multiple cycles. Exactly the due diligence you've already learned to do. The lockup that pressures a near retiree matters less when you're holding for income rather than an exit. Pair this with syndications, you've got both diversification, concentration, same allocation, fund level breadth, plus a couple of high conviction direct investments. That is an S.
Moving on, the next one is where private market experience moves the grade. BDCs or business development companies. BDCs provide higher yielding loans to small and mid-sized companies, then distribute [snorts] most of their taxable income to shareholders. Many public traded BDCs yield 8 to 12%. These trade on public markets, so liquidity is fine. The complexity is on the mechanics side. BDCs use leverage. The loan portfolios concentrate in particular sectors and distributions are generally taxed as ordinary income. For someone who's evaluated private credit funds, that complexity is familiar territory. You can read the portfolio, you can stress test the leverage. The grade goes from C to a B for our persona.
Next is one most people have never considered from an income perspective. Royalties and IP income. Think music catalog, patents, brand licensing. The income is uncorrelated to stocks and real estate, which is genuinely valuable for diversification. The market is less mature and the due diligence is complex. But if you take the time to understand the space, this can be a genuinely good income source. With the discipline that you've already developed evaluating private deals, that's a learnable edge. The real discipline here is sizing. Start small with a fund vehicle. Learn how the cash flow behaves. Scale only if it earns its place. That's a grade B. Understand and size right, it pulls its weight.
And last, preferred stocks. Preferred stocks are a hybrid between bonds and equity. Typically 5 to 7% yields, good liquidity through diversified ETFs. They pay fixed or formula-based dividends that rank ahead of common dividends. So income is more predictable than common stock dividends. The watch-outs, prices are significantly affected by interest rate moves and credit stress. They're not as stable as short-term bonds, and dividends can still be suspended in distress scenarios. I give these a C grade, useful for income diversification, but rate and credit sensitivity require attention.
So, that's the full ranking. All rated through the lens of our $5 million investor 5 years out with private market experience, a semi-liquid preference, and a hard eye on tax efficiency, fees, and operator quality. Now, owning more vehicles isn't the same as being diversified. And for someone with private deals already on the books, this is where the most common mistake shows up, concentration disguised as diversification. Real diversification within income comes down to five dimensions.
One, by income source type. Some income from equity matters. Some from real estate, some from interest-bearing instruments. When one source is under pressure, the others aren't necessarily affected.
Two, by liquidity profile. Liquid positions give you flexibility. Illiquid positions give you premium yield. For our persona, because you're building an income engine, you won't drain, you can carry more illiquid weight than somebody already living off their portfolio, but you still want a meaningful liquid floor.
Three, by operator. In the higher yield illiquid vehicles especially, you're not investing in the asset class, you're investing in the people running it. Never concentrate these positions with a single operator, no matter how strong their track record. This is the trap I see most often with experienced private investors. They find one partner they trust, and they get overweight.
Four, by tax treatment. Some income is taxed as qualified rates, some at ordinary rates, some is tax-free. Where you hold each vehicle matters as much as which vehicle you choose.
Finally, five, buy interest rate sensitivity. Some assets benefit when rates rise, others get hurt. A portfolio that's sensitive in one direction creates vulnerability.
Now, if you have 1 million to 30 million dollars in net worth and you're ready to actually build your evergreen portfolio, I would love to have you at our next live workshop. It's a two-hour deep dive on the architect phase of setting up your own micro family office. You'll walk away with a legacy statement, an investment thesis, and a portfolio structure tailored to your goals. At the time of recording this, we've had over 2,000 people just like you come through this workshop. Head to wealthops.io/go or click the link below this video to register. Our next workshop is likely in just a few days. After you sign up, check out this video if you want to learn more about cover call ETFs. Let's keep building.