Income Portfolio Construction: Yield Targets, Position and Sector Caps, a Cash-Flow Calendar and Reinvestment Rules

What you will learn

• How to convert a net income need into the gross yield required after German tax.
• Three caps: position size, sector weight and share of total income.
• How to lay out a monthly cash-flow calendar from different markets' payment patterns.
• Reinvestment rules that keep costs low and keep cash away from the riskiest payers.

Explanation

Asset allocation and rebalancing bands are covered in the course "ETFs, Funds & Long-Term Investing". An income portfolio adds one dimension: the cash flow itself must be planned, not only the capital.

From net need to gross yield

Start from the net income you need, not from a yield you find attractive. German flat tax on dividends is 26.375 percent (church tax ignored) above the Sparerpauschbetrag of €1,000 per person (as of 2026). So: gross needed = allowance + (net need − allowance) / 0.73625, and target gross yield = gross needed / capital. If the result is above roughly 4.5 percent, the honest conclusions are more capital, a lower target or planned partial sales (lesson 10). Forcing the yield up is how yield traps enter a portfolio.

Three caps

• Position cap: no company above 5 percent of capital at purchase, which forces at least 20 positions.
• Sector cap: no sector above 20 percent of capital; otherwise an income screen hands you a single interest-rate bet in staples, utilities, telecoms and energy.
• Income cap: no single position may supply more than 8 percent of total projected income. This is the cap most investors forget. A 5 percent position with a 7 percent yield in a 4 percent portfolio provides 8.75 percent of income; if it cuts, the damage to cash flow is almost twice its capital weight.

Add a currency note: record the share of income arriving in dollars, pounds and francs; it moves with exchange rates even when the dividends themselves are stable.

The cash-flow calendar

Payment patterns differ by market. Most US companies pay quarterly, in one of three cycles: January/April/July/October, February/May/August/November or March/June/September/December. Most German and many other continental European companies pay once a year, mostly between April and June. UK companies often pay twice a year, and many REITs pay quarterly or monthly. A calendar is a 12-row table of expected receipts; its purpose is to show the thin months, not to smooth them at any price. Choosing a weaker company because it pays in January is a mistake; a small cash reserve is the correct tool.

Reinvestment rules

1. Dividends collect in the settlement account; reinvest when the balance reaches a minimum (for example €1,000) so that order costs stay below about 1 percent.
2. Reinvest into the position that is furthest below its target weight and still has a safety score of 7 or more (lesson 11). Never reinvest into a company that is on review after a cut.
3. If every candidate is above a cap, add a new name from the watchlist instead.
4. Once a year, compare realised net income with the plan; adjust the target, not the risk.

Worked example

Hypothetical example: capital €400,000, net income needed €12,000 per year, one allowance of €1,000, no church tax.

• Gross needed: €1,000 + (€12,000 − €1,000) / 0.73625 = €1,000 + €14,940.58 = €15,940.58.
• Target gross yield: €15,940.58 / €400,000 = 3.99 percent, achievable with quality payers without stretching.
• Caps: position cap €20,000; sector cap €80,000; income cap 8 percent × €15,940.58 = €1,275 per position. A full €20,000 position may therefore yield at most 6.4 percent (€1,280 would already breach); higher-yield names must be smaller.

Calendar for a €100,000 slice of five positions, €20,000 each (gross, euros):

Monthly gross: Jan €150, Feb €200, Mar €175, Apr €650, May €1,100, Jun €175, Jul €150, Aug €200, Sep €175, Oct €650, Nov €200, Dec €175; total €4,000, 4.0 percent on the slice. The thinnest month gives €150, the fattest €1,100: the answer is a reserve of about two months of spending, not a search for January payers.

Common mistake

Practice activity

On paper: capital €250,000, net income needed €9,000, allowance €1,000. (a) Calculate the gross income and gross yield required. (b) Judge whether the target is realistic. (c) A planned position of 7 percent of capital yields 6 percent while the portfolio yields 3.8 percent; does it breach the 8 percent income cap?

Key takeaways

• Derive the gross yield target from the net need and the tax rate; above about 4.5 percent, change the plan, not the quality bar.
• Three caps: 5 percent per position, 20 percent per sector, 8 percent of income per position.
• Build a 12-month calendar to see thin months; cover them with a reserve, not weaker payers.
• Reinvest in minimum lots into safe under-weight positions; never into a name on review.

Next step

In the final lesson you write your income plan: a twelve-month projection, a reserve rule and a response rule for a dividend cut.