Why I invest in an Income portfolio

[daveh]

Dealtn asked why I was investing in an income portfolio when I don't take the income (at the moment) and not in an alternative TR strategy that might produce a larger pot at the end of the day. Rather than derail the HYP v CTY thread I've started a separate thread as Dealtn suggested.

For information I personally run an Income portfolio that includes the usual HYP shares from the UK, two pref shares, three high yield ETFs for europe, emarging markets and Asia Pacific and recently money has gone into ITs HFEL and MCT and into Vangaurds all world ETF tracker VWRL. I've not recently invested in any UK ordinary shares as the ones that are still yielding are sitting at too large a % of my portfolio and I'm not sure I want to add new holdings as I'm already up at 41 holdings including the ETFs and ITs. I'm not taking income from itat the moment and am reinvesting dividends plus subscribing the full ISA allowance.

If it's not too rude a question, can I ask what made you choose to run an "Income" portfolio, when you aren't drawing that income but reinvesting it?

Do you believe that the reinvestment, and eventual capital size at the point you beginning drawing down income, will be superior by choosing that subset of shares/funds, over alternatives, or is there another reason? At the end, and with hindsight it might well have turned out to be the best approach, but I am just wondering (hopefully in a non-accusatory or rude way) why you are limiting your potential pool of investments at all, and why to "Income" ones in particular?

I started off reading MF many years ago and actually started running a PYAD26 (I think it was called) mechanical portfolio. When PYAD talked about the HYP method on MF I felt the idea better matched my psychology. I like the idea of buying an income and seeing the income increase each year (bar the odd year when it didn't - 2009 is my only year that the income was less than the previous years and I predict this year will be the second!). I don't necessarily think it will be/have been the best way to produce total return - but it suits me and up to know I've been happy with the results. We'll see what returns are like after the Corona virus crisis and whether I'm still happy.

I'm a scientist and I'm employed on short contracts (so far touch wood, regularly renewed) and I liked the idea of building an income that I could take if necessary if I had a hole in my employment history, just by taking the dividends.

I've not been a complete adherent to the strict HYP idea as described on the practical board in that I hold prefs, ITs and ETFs and have recently bought VWRL, which is by no means high yield. I actually looked at buying either VWRL or VHYL, but VWRL has the better performance. Be interesting to see if I made the right choice.

[dealtn]

Thank you for your reply.

I think you are right in "practical" terms, especially in an uncertain world, that there is merit in having a strategy that you are not only comfortable with in terms of understanding, and have faith in, but also has the flexibility to change (at limited cost of changing direction).

Some of this is in simple diversification, but I think there is merit for those whose income maybe uncertain, or variable. at least more so than expenditure, that the ability to maintain a strategy but "switch" the income from re-investment to, er, income, has something to be said for it.

[Itsallaguess]

Some of this is in simple diversification, but I think there is merit for those whose income maybe uncertain, or variable. at least more so than expenditure, that the ability to maintain a strategy but "switch" the income from re-investment to, er, income, has something to be said for it.

This type of question crops up quite a lot.

I tried to answer a similar one last year that it's probably easier to link to than repeat in full -

The additional benefits, to me at least, of taking a more 'reinvesting income' approach to my investments, even whilst still working, are that it both enables me to track and largely predict the amount of income and income-growth that my single-strategy approach is creating, and hence how that might be tracked in future, which helps me to manage my long-term career and any potential retirement plans, and it also provides me with a single 'income-switch', which sits right at the very heart of my single-strategy approach, and which is currently switched to the side that says 're-invest income'.

If and when the time comes when I want to take, rather than re-invest that income, all I have to do is throw that switch from 're-invest income' to the side that says 'pay out income', and the whole of my investment strategy will stay exactly the same except for the fact that I'll then be taking, rather then re-investing that portfolio income from that time.

So whilst you might think that it's 'pointless' to take investment-income and then re-invest it, I think that view removes any credit that might be taken on the 'process' side of things, and the longer I go on investing, the more I find myself thinking that the 'process' side of things is, to me at least, of equal importance if not more so than a comparable 'total return' figure might be if I were to take a more 'multi-strategy' approach to things....

https://www.lemonfool.co.uk/viewtopic.php?f=31&t=19869&p=257313#p257313

I'm happy to give up a notional amount of total return if there is some benefit on the process side of things.

Some people seem to have some difficulty with that line of thinking, but I see that as their problem, and not mine...

Cheers,

Itsallaguess

[Alaric]

I'm a scientist and I'm employed on short contracts (so far touch wood, regularly renewed) and I liked the idea of building an income that I could take if necessary if I had a hole in my employment history, just by taking the dividends.

A self=financed unemployment insurance as it were. The worry would be that the social or economic circumstances that left you between contracts correlated with cuts in dividends. But if you have fixed income, Prefs, ITs, overseas etc. those mitigate.

[1nvest]

The FT100 index has been a tilted portfolio that has seen such tilt backfire. Heavily tilted into sectors that turned sour such as financials across the 2008/9 financial crisis. HYP1 (started Nov 2000) was more of a equal weighted portfolio/index. A better benchmark index for that IMO is the FT250 index as that feeds stocks both in and out of the top and bottom such that no one stock tends to become overweight (unlike large cap index that can have 10% weighting into a single stock, and at times 25% or more weighting into single sectors). Comparing HYP1 to FT250 and the two much better aligned in total return, but where HYP1 paid higher income (dividends), saw less capital growth.

If you adopt a SWR style of withdrawals/income production then any portfolio can have the same measures applied as income is taken out of total returns, and again HYP and FT250 have broadly compared. Alternatively you could have drawn the exact same income from FT250 total return as paid out by HYP and seen broadly similar overall results.

Increasing SWR even a little can make a massive difference to outcome, too high a value and failure (drawdown) become evident at some level of SWR. One way to reduce risk is to use a lower SWR, not draw too much. Higher (dividend) income is comparable to using a higher SWR, that induces greater risk. Historically a 4% SWR (income) was successful in many cases, but did have failures. At 2% SWR broadly stock portfolios were safe, pretty much no occurrences of failures. At 5% and higher levels, whilst some were successful, so the risk of failure increased substantially. As a ballpark guide, HYP1's 2016 review had its capital value 2.0 times higher than its start date capital value, and averaged around 4.3% dividend yield, which might be considered as a form of SWR. FT250 in contrast saw its capital rise 2.6 times whilst paying around a 2.5% dividend. Similar overall total return, but where one in effect was using a lower SWR compared to the other.

When you're reinvesting dividends SWR risk is moot. But that is still giving up stock book value. If a £10/share book value stock is priced to 2 times book-value, £20/share, as at that price its paying a 4% dividend yield, 80p dividend amount then that's a 80p amount lowering of the firms book-value ... all else being equal a decline from £10/share book value down to £9.20/share book value. If you reinvest the dividend the firms book value remains unchanged, its just a transfer of the dividend capital into another investors pocked (who sold you the shares).

Higher yield bears greater risk in reflection of being comparable to a higher SWR and faster erosion of book-value. Often, provided not too high/fast, that works out, other times it doesn't work out. With lower income the risks tend to be lower. Diversification also tends to reduce risk. Rather than being solely invested in one type of stocks - those that are in effect progressing a higher SWR type policy, diversifying into other choices is akin to diversifying down FT100 type over-concentration type risks - that at times can backfire. I suspect that HYP risk of seeing lowering/cutting of dividends, that often entails large declines in share prices for having done, so will become more evident since Covid-19, and indeed it looks like there is a gap already widening between HYP and the FT250 due to the FT250 being more widely/evenly diversified.

It's a concentration risk factor to specifically invest for "income" - better to more broadly diversify. Same holds for "growth". Diversifying across each of price appreciation, income and volatility capture (that more often just involves simply periodic rebalancing back to target weightings) is less prone to (over) concentration risk.