Academy/Risk Spectrum Course/Part 2

The Bedrock: Defensive Income (Tiers 1 & 2)

Before you chase 50% yields, you must build a foundation that cannot be destroyed. Tier 1 buys you sleep; Tier 2 buys you a pay raise.

Key Takeaways

  • Tier 1 (The Cornerstone): Cash equivalents (Treasuries/MMFs). Zero principal risk. Yield comes from the Fed rate.
  • Tier 2 (The Foundation): Dividend Growth stocks. Lower starting yield, but the payout grows faster than inflation.
  • The Allocation Rule: Most portfolios should have at least 30-50% in these tiers to offset high-yield volatility.
  • The Goal: Total Return. These assets prioritize growing your equity over maximizing immediate cash flow.

Tier 1: The Cornerstone (Cash & Equivalents)

Definition: Assets where the probability of losing principal is effectively zero.
The Contract: "I accept the Risk-Free Rate (currently ~4-5%) in exchange for absolute liquidity and safety."

In a high-interest-rate environment, Tier 1 is not "dead money." It is your dry powder. When the market crashes, Tier 1 is the only thing that doesn't drop.

Examples

  • SGOV (0-3 Month Treasury)
  • BIL (1-3 Month Treasury)
  • USFR (Floating Rate)

When to Buy

Store your emergency fund here. Also use it to "park" cash while waiting for a market correction.

Tier 2: The Foundation (Dividend Growth)

Definition: Companies or Funds with a history of raising dividends.
The Contract: "I accept a lower yield today (2-4%) because I expect both the stock price and the dividend to double over time."

This is the wealth engine. If Tier 1 protects you, Tier 2 makes you rich slowly. These companies typically have wide moats and strong cash flows (e.g., Coca-Cola, Home Depot, Broadcom).

The "Yield on Cost" Magic

If you bought SCHD in 2012, your yield today isn't 3.5%. It's over 10% on your original investment. This is the power of dividend growth. Tier 4 and 5 funds rarely offer this; their payouts tend to decay.

Tier 2 Examples

  • SCHD: The gold standard for US dividend growth quality.
  • VIG: Vanguard Dividend Appreciation (Focuses on growth streak).
  • DGRO: Core Dividend Growth (Broader selection).

The "Sleep Well At Night" (SWAN) Factor

The biggest mistake income investors make is ignoring these tiers. If your portfolio is 100% in Tier 4/5 (High Yield Options), a market correction will devastate your income and your principal. Tiers 1 and 2 act as the ballast. They keep the ship upright in a storm.

Related Glossary Terms

Dividend AristocratsDividend Growth RateSCHD Factor StrategyDRIPView All →
Part 1: The Income IllusionPart 3: The Sweet Spot (Tier 3)