#632601
Postby funduffer » December 8th, 2023, 3:37 pm
This is an interesting thread, as it is about HYP total return, which is not the first think HYPers worry about.
I have had a HYP for nearly 10 years, which I bought outright at the start, and only added to when I got new capital.
My comments on total return and risk are:
1. I have seen no evidence HYP is the best vehicle to accumulate capital, prior to drawing income. Indeed, pyad only proposed HYP as a mechanism for drawing income from a portfolio. Whilst I can see sense in setting up a HYP prior to requiring the income as a means of learning, this could be done with a small fraction of the available capital until drawdown time comes. A better total return in the accumulation phase, with less risk, would be a world tracker fund I would suggest.
2. Once drawdown starts, total return is less relevant compared to security of income or income volatility. The risk to income is that it falls significantly causing distress to the investor if they rely on this income for daily living. To quantify this risk, you would need to compare HYP to the risk and reward from alternative drawdown investment vehicles. These might be an annuity, a personal pension, or selling down an investment portfolio regularly. For the latter, there are umpteen articles on the so-called Safe Withdrawal Rate (SWR). Many of these have looked over many durations and start times, and different stock markets, to establish the risk of running out of capital (and hence income). Broadly, the conclusion is a SWR is probably a bit less than 4%.
3. So how does this compare to the risk from a HYP? I don't know the answer, and there are so few well documented HYP's that it is impossible to quantify the risk. However, HYP's generally yield more than 4%, so you could say they are riskier than regularly selling down a portfolio with a 4% WR. So I would describe HYP risk as the risk of losing x% of income year on year (after inflation). To some a 10% year-on-year reduction in income would be nothing to worry about, to others it would be very painful. Thus level of HYP risk tolerance is personal.
4. One can reduce the risk in falls in income by 'de-risking' as Luniversal would call it - i.e. keeping some of the income back each year in a cash buffer to mitigate for years where dividend income falls. The level of cash buffer must relate to how 'painful' a loss of income would be to the investor. On the face of it, I would have thought re-balancing a HYP would reduce the risk of income volatility, but again there are too few examples to be certain.
5. What about total wipe-out (100% loss of income)? It is possible that selling down a portfolio for income at a 4% withdrawal rate can lead to wipe-out of the capital. So presumably, this is also possible for a HYP, particularly one yielding >4%. But as arb says, if the HYP capital fell to zero, we would have to worry about other things than HYP income as the UK stock market would have become more or less extinct!
If we had a large universe of HYP examples we could probably establish the risk in HYPs, but we don't, so we will end up debating them endlessly!
FD