Oh my goodness, I could write so much about this and I'm going to because this seems the appropriate thread to get this off my chest. I'm particularly glad to see one particular Fool (Alaric) has participated in this thread because this involves you Alaric! My recent investment journey might also be of interest to some so I will outline it in some detail.
tl;dr - for me I found that changing the way I monitored my investments had a profound change on how I thought about them and has completely turned my investment world upside down; and Alaric is my accidental hero to whom I owe enormous thanks.
pendas wrote:Has anyone given thought to this?
If as an income seeker you merely see capital as a means to an end, at what point would you start to draw on the capital to supplement the income?
Have I given thought to it? Yes. I started thinking about it at 12:28 pm on 13th May 2019 when a certain previously-named Fool made an observation on a post I had made bemoaning some recent dividend cuts. I was worrying that any more cuts would, after 10 years of living off my HYP, finally put me into the situation where my un-tax-sheltered divi income would be insufficient to meet my desired annual spending. For the first time ever I was considering having to draw some of my required income from the safety margin bit of my HYP which was sheltered in my ISA.
Then along came this (viewtopic.php?f=15&t=17634&p=221283&#p221279
Julian wrote: If something nasty were to happen to the VOD dividend then it would almost certainly tip me over the edge and require me to start drawing some income from my ISA for the first time since I started living off my HYP in 2009 (assuming I wasn't willing to cut my monthly draw which I wouldn't be).
You wouldn't take the alternative approach that leaving wealth inside a tax shelter was preferable? If so then you would supplement your income by disposing of holdings in the taxed account. That's subject to not having to sell so much as to incur Capital Gains Tax.
And BANG! In that instant Alaric quite literally changed my life. Everyone's life changes all the time but this really was the biggest change in my life in at least the last decade. For some reason that was the moment, and I really can pin it to that seemingly innocuous (and astute) little post from Alaric, when I finally broke my obsession with leaving capital intact and only drawing at most the income generated from it (at least as far as my income portfolio is concerned, I had been running a side portfolio focused on growth for a while but had never made a sell-off from it).
In that instant I decided to completely throw my entire existing investment setup into the fire and build something new that accommodated the concept of capital selloffs. I'll explain the before and after.
THE BEFORE (THE OLD ME)
A pretty traditional income investor who started out building an HYP in 2001 and transitioned to living off it in 2009 with no other significant sources of income. I was actually doing OK, I was affording myself a good lifestyle, but as alluded to above I was getting close to dipping into my safety margin.
I'm a spreadsheet freak and I like monitoring things and I had one critical spreadsheet called "Investment Income" that gave me a forecast of the minimum level of dividend income I could realistically expect for the current calendar year. It was driven off a database (another spreadsheet) where I diligently recorded the dividend distributions in pence-per-share and the payment dates for every holding in my income portfolio. My investment income spreadsheet could then calculate, based on most recent actual company declarations, exactly how much dividend would come from each share and in which months. Because I had a collection account with a float where all the divis were paid into and from which I paid myself a fixed standing order at the end of each month the actual month-by-month income wasn't really relevant and I assessed the health of my investments based on a single number which was the average monthly dividend income from my un-tax-sheltered income portfolio for the year. I was very much like Dicken's Mr Micawber in David Copperfield...
Annual income twenty pounds, annual expenditure nineteen nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds nought and six, result misery.
... in that if my standing order was £1,000 each month and my magic number (average monthly divi income over the year) was £1,001 result happiness, if the standing order was £1,000 but the divi income was £999 result misery. I also really did ignore capital value completely, I didn't monitor it in any way, I just focused on that single average monthly divi income number. Additionally the assets within my ISA and small SIPP were barely looked at, even in income terms although my spreadsheet also calculated the income arising from my ISA & SIPP accounts, because in my mind those were emergency assets that should never need to be touched except in some disaster scenario.
As a final point on the "before", some might wonder how I funded my ISA if I was so averse to selling off capital. I had a broker account that at one point generated sufficient income each year to fund the annual ISA subs. As the ISA allowance increased dramatically and after I sold off some of the holdings in that account to buy a holiday home the income was no longer sufficient each year to fully fund my ISA. There was however still a reasonable capital value in the account so starting from next year my plan had been to start using that capital for the ISA subscriptions. The income from that dedicated ISA-feeder account had never formed part of my "magic number" so sell-offs within that account would not have affected my Mr Micawber equation anyway, at least for quite a few years until the account was drained.
Given my obsession with monitoring and planning for the future, something inculcated in me by my father, I realised that the issue wasn't necessarily my investments per se but rather how I viewed them and how I viewed them was driven by how I monitored them. If I was to break free of my obsession with never drawing down capital, which in my mind was inextricably linked with going backwards due to the fact that it would reduce that all-important average-monthly-divi-income number so was 100% a bad thing, I had to build new monitoring tools that moved away from exposing me to that single magic number (average monthly divi income from my non-tax-sheltered core income portfolio) and instead gave me a new metric, ideally also a single magic number, that I could look at as required to determine whether I should be experiencing happiness or misery. My task then became simply one of working out what to monitor and building the tools (spreadsheet) to do it. This took me a few very enjoyable weeks to do. (Spoiler alert - I was able to come up with a single new magic number to replace my old average-monthly-divi-income number and that new magic number is currently 2.63.)
I have made no changes in my investments except for selling all of my Centrica and SSE holdings which the old me was about to do anyway since the old me had a hard time coming to terms with divi cuts in my portfolio because they immediately reflected as a reduction in my magic number so I wanted to get ahead of possible future pain. What I have done is changed the way I monitor and hence manage my investments.
THE AFTER (THE NEW ME AFTER MY INTERNET ENCOUNTER WITH ALARIC)
The flow of money is now as follows...
I still have the same divi collection account where all of my non-tax-sheltered dividends are paid into but this now gets slightly more income. Previously this account only collected the divis from my income/HYP accounts. The dividends from my growth portfolio that I did briefly mention earlier were paid into a separate account really to protect my old magic number. I wanted to see monotonic increases in my magic number, something I could reasonably hope for with well-chosen HYP shares and income ITs but, since shares in my growth portfolio were selected with no consideration of their dividend properties, they would have disrupted the desired behaviour of my magic number if their dividends gyrated too wildly year-on-year. Because that old magic number is no longer really looked at I don't care what happens to the income stream (except how it eventually feeds through to my new magic number) so I also redirected all dividends from my growth portfolio into the same collection account as my income portfolio and closed the separate growth portfolio collection account. The remaining collection account is still the one that pays me my monthly standing order that I use to live off.
The key difference now is that my collection account doesn't fund its monthly standing order obligations from divis coming in month-by-month from my investments(plus a smoothing float), it is instead primed once at the start of each year with a capital sum equal to 12 x the monthly standing order plus £20K for that year's ISA sub plus whatever my tax liability is going to be for the year (which, provided that I file my tax return my 31st December I will know when I prime the income account on 1-Jan how much the January balancing payment plus the two Jan & July payments on account will be). This is obviously quite a big sum so it doesn't actually all sit in the collection account for the entire year, I have a linked savings account where most of it is parked for the year and each month I have an auto-transfer set up to move enough back into the collection account to fund that month's standing order. This now means that the income coming into the collection account over the year is irrelevant to the current year, it simply accumulates such that over the year the balance in the collection+savings-account system will be equal to all dividends received from all of my investments (excluding ISA and SIPP) over the year. The only manual part of this system is that I periodically log into my income account so that I can scrape dividends accumulated across to the linked savings account to optimise the interest that I earn.
At the end of the year I then need to sell sufficient capital to make up the difference between the dividends that I have accumulated during the year just ended and the amount that I need to recharge the collection+savings accounts for the year just starting. My monitoring tool shows me this number and the exact amount of selloff expected to be needed will vary constantly over the current year since dividend increases will reduce the amount of capital selloff needed whereas divi cuts will increase the figure. This expected capital sell-off figure, although useful, is not my new magic number so I don't really care whether it goes up or down.
So that's how it all works now but what is my new magic number? This won't work for many people because I admit that I am lucky enough to be quite well off but after this rather long post I should finish the story and maybe it will be of use to some people, or trigger other ideas.
My new way of monitoring the health of my investments is to introduce the concept of a "zero point" into my planning and that zero-point is the point in time (measured to the precision of a calendar year) at which I expect all the capital in my non-tax-sheltered investments (i.e. all of my growth and income holdings) to have been eroded away by my year-end sell-offs. The zero-point is calculated by modelling the decay of my investments, factoring in lost income each year from sell-offs, adjusting HMRC tax liabilities due to declining un-sheltered divi income, and factoring in state pension kicking in at 66. It also models the growth of income and capital value for both my ISA and my SIPP since my start-of-year top-ups include a provision to fully fund my ISA contributions plus both my ISA and my SIPP are accumulating dividends to be re-invested every year up until zero-point is reached.
My new magic number is a ratio derived from the zero-point model. It is the estimated average monthly dividend income that the zero-point model predicts that my ISA plus my SIPP will be generating when I reach zero point divided by the monthly income that I currently draw but excluding from my currently drawn income any ISA contributions (since once I reach zero-point there will be no funds left for ISA contributions) and assuming no HMRC tax liabilities (my SIPP is small and not getting new contributions so I am assuming anything drawn from my SIPP after zero-point will fit within the nil-rate band; that's perhaps overly optimistic since it would be sharing that nil-rate band with my state pension so I might refine that calculation in a future iteration of my spreadsheet). It's this ratio that currently sits at 2.63 and that is extremely healthy. If it was exactly 1.0 my magic number would be indicating that, if things go as per my model, I would seamlessly sail through zero point such that, in the year when my non-tax-sheltered funds are depleted, the annual divi income being generated within my ISA and SIPP would be exactly enough to continue to pay the same monthly amount into my account each year minus any provision for ISA contributions or tax liabilities (those two exclusions as previously explained). Any figure above 1.0 indicates that my zero-point income could afford me a bigger monthly draw than I was taking prior to zero-point (happiness) and a figure below 1.0 indicates that I would have to reduce my monthly draw once I reach zero-point (misery).
Since my zero-point is currently predicted to be at age 93 I am likely to be in my dotage so I am deliberately investing my ISA and SIPP along income IT "basket" lines (as in LUniversal's concept although not exactly his constituents) in the hope that it will be maintenance free and, although the performance might not blow the roof off, the income stream should keep pace with inflation at least. (Inflation hasn't been mentioned since I am assuming that increases in capital values and dividends between now and zero-point will at least cancel out any inflationary increases that I need to make to my monthly standing order payouts over the years.)
My new magic number is going to be far more volatile than my old one since it is affected not only by dividend declarations but also by day-to-day share prices, some days it will go up and some days it will go down, but as long as it remains in a safety zone that I have not quite decided on yet (maybe somewhere between 1.20 and 1.50) I will be happy that I am drawing a prudent and sustainable level of income from my investments potentially in perpetuity.
This exercise has been 100% successful in decoupling me emotionally from concerns regarding fluctuations in my divi income, I really don't care anymore to the extent that they are not explicitly visible to me although I do still maintain my database of dividend declarations since it feeds into my zero-point decay model. I don't even go and look at any of my income numbers anymore after I update a divi declaration whereas in the past I would immediately go and look at what effect it had had on my old "magic number". After these changes I am also 100% comfortable that I am still monitoring my investments closely enough to be prudently planning for the longer-term. That previous anathema of capital sell-offs is now at the core of my new financial strategy and it no longer concerns me in the least. As an unexpected bonus I also discovered, once I'd built my new monitoring and planning tools and looked at the numbers, just how much leeway I had to actually draw more income than I had been doing previously; I have gone from worrying that potential dividend cuts might require extra unwelcome measures to maintain my previous level of monthly standing orders (unwelcome measures = raiding my ISA income as per the original exchange with Alaric) to having now increased my monthly standing order by just over 15% and, from the very healthy 2.63 reading on my new magic number, I think I probably have scope to increase it further in the future (over and above regular inflationary increases). I'm still adding a fairly sophisticated "What If" section to my new monitoring spreadsheet and once that's done I can play with some options, downside risks, etc.
The result of all of the above is that I have gone through such a profound change in my attitude towards my investments since 12:28 pm on 13th May 2019 that a number of friends have, without any prior explanation from me, commented on how much more relaxed and at ease I have been recently and I certainly feel that within myself.
And finally, if you got this far Alaric, I know you couldn't possibly have foreseen what effect that simple 46 word post would have but it really did precipitate some changes in thinking on my part that have improved my life immeasurably so a heartfelt (and belated) thanks to you for your 13th May post.