TR versus HYP (income strategies)

[Itsallaguess]

No pure income investment has managed this outcome the last 18 months.

Please see my previous reply, specifically regarding the imagined bitcoin investor...

Cheers,

Itsallaguess

[Dod101]

If you are living off a HYP and there is a serious crash, your dividends will be hit hard, and you will have to live off whatever is left of your dividends and capital. In the very long term higher yielding shares have outperformed the market, but only as compensation for the extra risk. When high yield shares are popular, as they are now, they command a premium price, and the returns going forward are likely to be lower.

I lived through the 2008/9 crash and I survived living off my dividends (which although saw drops not all dropped very much)

I am not at all sure that high yield shares command a premium price. Legal & General, AstraZeneca, HSBC and Shell, to name but four are, not withstanding the capital increases we have recently seen, yielding well above their historic yields and actually still yield more than the market average. There is not much by way of a premium price in those shares.

I have not done any study of the matter but I do have 20 years of practical experience of living off my dividends and whilst there may be better strategies, this strategy works and I have had to contend with the tech boom and bust in 2000 and the banking crisis of 2008/9. I would much rather rely on dividends than on TR and maybe be forced to sell at just the wrong time.

OTOH I cannot knock Fred's idea; it is just not a long term strategy for me.

Dod

[tramrider]

And, yes again. I describe my strategy as "opportunistic total return investing". I think it fits quite well. But, no, it is not a one time opportunity at all really. If the TR strategy continues to deliver, it's simply a case of rinse and repeat.

A pure income strategy can't match this kind of return. Though I do recognise the tail wind we've had the last few years has been a big help.

In trying to make your exceptionally good TR result into a general case, I think you need to be more realistic. For most of us, perhaps because we have an income bias, our TR tends to be about 10% per annum in normal years. For example, one of my portfolios has a better XIRR of 13.4% due to the recent rise in the markets. Expecting your 40% per annum as a norm is probably very unrealistic on which to base a long term strategy.

However, I totally accept the wisdom of banking some of your very high recent returns, in case of future market falls. Surely this is the normal method in a say 60%/40% equity bond portfolio. When the shares are doing well, you cash some in and transfer them to somewhere safer. I understand that you are advocating a bank deposit rather than bonds, but somewhere with half the dividend yield of shares would help cope with our present rate of inflation.

So perhaps you should state your case as rebalancing from good total returns into something safer, rather than stressing the lower return on income shares than from what must have been exceptionally growthy shares. Perhaps you could mention a few of them.

Tramrider

[CryptoPlankton]

It sounds like an excellent strategy. Could you please let me know what to invest in to make 60% over the next 18 months and I'll sell up all my boring income-oriented holdings immediately!

Sarcasm? I'd love to invest your money for the next 18 months and hand you a 60% appreciation. But I can't. Sorry about that. Now, if you'd given me your money 18 months ago..........

But that is the whole point. Your "strategy" is only a strategy now that you have achieved those gains. Having done so (and well done, by the way) there is probably some merit in what you propose. I could equally as well say that I put everything on red at roulette last night and made 100% on my investment (I didn't, of course). As a result, I have twenty years' worth of income at 5% on my initial sum that I can squirrel away and still have 100% left to invest. Even the best TR investment I've read about recently has only returned 60% over a much longer period so why would I choose that over my strategy? But if I were to suggest it as a strategy BEFORE winning you'd laugh in my face.

As has been pointed out, as a starting strategy it is very dependent on successful market timing. You have already said that you have been assisted by "tail winds" and that a correction is inevitable. So, if you embarked on this strategy today, hit a bear run and ended up 30% down in 18 months, what would be your next move? If you need income from your investments (which is what I think your proposal assumed?) depleting the portfolio further by withdrawing funds would make it even harder to return to your starting value. Given this scenario, I would be far more comfortable withdrawing (even reduced) dividends than having to part with capital.

I'm not an evangelist for pure income/dividend strategies and I have several investments (biotech, EM, small caps etc) looking for capital appreciation, but as an income strategy (BEFORE the realisation of the 60 % gain) your proposal seems far too risky. As a strategy for AFTER the 60% gain then it is only hypothetical for those of us who haven't successfully completed that stage.

[GeoffF100]

I lived through the 2008/9 crash and I survived living off my dividends (which although saw drops not all dropped very much)

I am not at all sure that high yield shares command a premium price. Legal & General, AstraZeneca, HSBC and Shell, to name but four are, not withstanding the capital increases we have recently seen, yielding well above their historic yields and actually still yield more than the market average. There is not much by way of a premium price in those shares.

I have not done any study of the matter but I do have 20 years of practical experience of living off my dividends and whilst there may be better strategies, this strategy works and I have had to contend with the tech boom and bust in 2000 and the banking crisis of 2008/9. I would much rather rely on dividends than on TR and maybe be forced to sell at just the wrong time.

2008/9 was not a proper crash by historical standards.

The big stocks of the FTSE 100 have had a good run lately. Who is to say that they are not getting over-priced? Most HYPs contain shares in much less solid companies. Carillion is the example currently in focus. A lot of HYPers were very keen on it a while back.

20 years experience is nothing in the stock market. Why do you place a higher weight on your limited experience than the aggregated experience of all the people who have ever invested in a stock market? The clement markets of recent times give a false sense of security.

[vrdiver]

2008/9 was not a proper crash by historical standards.
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<snip>
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Why do you place a higher weight on your limited experience than the aggregated experience of all the people who have ever invested in a stock market?

Well, Wickipedia seems to include it as one of the historical crashes
The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s. https://en.wikipedia.org/wiki/Financial ... %80%932008

As for the other comment I've quoted, most of us aren't interested in the "aggregated experience of all the people who have ever invested in a stock market", we're interested in our own time frame our own market and our own investment strategy. Dod's example of "living off dividends" is very real and up-to-date; why do you dismiss it?

[Itsallaguess]

20 years experience is nothing in the stock market.

And yet a whole TR strategy based on an 18-month experience of an 'exceptional capital increase' seems to be the selling point of this particular thread....

Cheers,

Itsallaguess

[Dod101]

2008/9 was not a proper crash by historical standards.

The big stocks of the FTSE 100 have had a good run lately. Who is to say that they are not getting over-priced? Most HYPs contain shares in much less solid companies. Carillion is the example currently in focus. A lot of HYPers were very keen on it a while back.

20 years experience is nothing in the stock market. Why do you place a higher weight on your limited experience than the aggregated experience of all the people who have ever invested in a stock market? The clement markets of recent times give a false sense of security.

I agree that 20 years experience in stock markets is not very long. I had about 5 years before that when I was not particularly into high yielding shares. The tech bust of 2000 changed my mind on that. Was it a proper crash? I will be glad to know.

I do not think you read my posts. The last thing I ever do is to suggest that my limited experience is better than the aggregated experience of others. That is the road to ruin. We must always be on our guard and I completely agree that the clement markets of about the last ten years can easily give a false sense of security. All I can do is quote my experience and draw conclusions on what works for me. Naturally, like most of us I guess, I tend to use my own experience when commenting on public boards like this. How could it be otherwise?

On that basis, I am prepared to say that IMHO the shares that I quoted are not I think 'getting over priced'. I have never held Carillion and any time I did mention it was to say that I thought it should be avoided, like the supermarkets.

Anyway I know what works for me and you are entitled to your observations. They make interesting reading.

Dod

[Lootman]

Given that we invest for wealth enhancement that we can live off and spend as we choose I reflect that since I moved my portfolio from HL to II in June 2016, the portfolio value has increased by 60%. Much of this reflects the general market tail wind and the 60% gain is mainly capital appreciation from a small number of funds and a small number of shares.

If I cash in the 60% gain and choose to spend it, it will last me for 12 years spending it at a rate of 5% a year. My portfolio remains intact and can fall/rise at the whim of the market but the "income" would be sitting in the bank, ready to spend.

What you describe is somewhat similar to what I do, and have done for a good number of years. However, when you say "we invest for wealth enhancement that we can live off and spend as we choose", I know what you mean but would put it a little differently. I invest to achieve a sustainable stream of cashflows.

The "sustainable stream" there means that the cash generated must meet my needs, which are reasonably expected to grow at, say, 5% a year. But for me that doesn't necessarily mean what people think of as "income". I use the word "cashflows" there very deliberately and specifically because, whilst they might derive from periodic "income" distributions (e.g. dividends or interest) they might also derive from gains, disposals or the selling of options against my positions.

In my case I am also guided by the fact that a lot of my investments are in taxable accounts. That means that I have to be careful with disposals not to pay CGT (almost all my positions show unrealised gains - some substantial ones). On the other hand I definitely want to use my CGT-free allowance each year so there are always going to be disposals.

And the approach I take towards cash is similar to what you suggest. It sits there to the extent that I don't currently need it with the assurance that I will spend it at some future point and, when I do, that will relieve the pressure on my remaining investments since I won't need to sell or draw dividends from them. If markets fall, I may reinvest at lower levels. If markets go up, then it's just cash I will spend in future years, which I would have had to do anyway.

So I do take a "total return" approach, whilst accepting that it's a privilege to have excess cashflows. If markets in the last decade or so had not been so favourable then my method would have been less successful, and I'd be more dependent on dividends, as well as having less funds at my disposal for whatever I want to fritter them away on.

The risk of a significant market decline is there, as discussed here. But my approach to that is both to have a cash cushion as stated above. And to use options to protect some of the value, when appropriate. Also the portfolio is gradually becoming more conservative as I build cash and reinvest in less volatile instruments.

The disposals also serve to simplify my portfolio which, at one point, had 200 securities. My aim is to have ten to twenty, and so these trades also serve to consolidate my exposure into a more manageable state, as well as ensuring that there is cash for several years worth of spending no matter what happens.

[GeoffF100]

The financial crisis of 2007–2008, also known as the global financial crisis and the 2008 financial crisis, is considered by many economists to have been the worst financial crisis since the Great Depression of the 1930s.

Yes, I would agree with that. However, the central banks have pumped so much money into circulation that asset prices and dividends have held up. Nonetheless, that may lead to trouble in the future. We are in uncharted waters.

All I can do is quote my experience and draw conclusions on what works for me. Naturally, like most of us I guess, I tend to use my own experience when commenting on public boards like this.

Of course we all do that. More importantly, we are all tempted to place a higher weight on our own direct experience than we do the experience of countless others over many time periods. If we beat the market, we are inclined to believe that it is beatable. I am inclined to believe that is more of a weakness than a strength.

I do have a UK portfolio, which would still pass as a HYP. It has done well over the years, but not so well over the last year or so. I have not had any significant losses, but it has lagged the international market. That is partly because it has a low beta. It lags the FTSE 100 when it rises, but also falls less hard when the market falls. The volatility is almost the same as that of the FTSE 100.

I am approaching my end of financial year trading, when I trim my largest UK holdings to fill my CGT allowance. I was thinking about using the proceeds to boost my overseas equity tracker holdings, but the optimism of this thread gives me pause for thought. Perhaps I would be better off buying bonds instead.

[hiriskpaul]

I have been reading this book, which investigates, tests and recommends best practices for living off investments.

https://www.amazon.co.uk/Living-Off-You ... 0997403403

One of the best methods the author has identified is to divide your pot into two. One pot containing very low risk, low volatiltiy assets, mainly bank deposits, short-intermediate dated government bonds, indexed linked bonds. The other pot contains the risk assets, mainly shares. Income is drawn from the low volatility pot. Dividends from the risk pot are reinvested. When the inflation adjusted value of the risk pot has risen by 20%, 20% of the pot is sold and used to top up the low vol pot. If the income pot is exhausted, the strategy then moves on to drawing down from the risk pot. This TR harvesting approach is very similar I think to what Fred has suggested, but following a systematic strategy rather than opportunistic selling. It is impossible to test anything other than systematic strategies anyway.

Best practice for the risk pot is to make it internationally diversified, but otherwise pile it high with risk - overweight value, small caps and emerging markets.

[tjh290633]

If I get this right, your portfolio has grown by 60% and you are proposing to sell 60/160ths, which will reduce your income by about one third. To replace that income you propose to cash in 5/160ths each year for 12 years.

Now, had you retained the investments that you would sell, and the dividend income from those had grown at a modest rate, the odds are that your income from the original portfolio would have grown to be more than your 5/160ths.

You may be expecting capital values to fall, but dividend income has historically held up during such falls, 2008-9 notwithstanding.

TJH

Nope.

I have no portfolio derived income right now, it's all TR.

18 months ago in my portfolio I had 100.

Now I have 160.

I crystallise 60.

Leaving 100 invested for TR.

The 60 I divide by 12 into chunks of 5.

I spend 5 each year for 12 years.

I still have 100 invested for TR, which, perhaps will continue to grow. And may or may not take another haircut as and when required. I can think of no circumstance where a pure income portfolio can achieve this outcome.

My real point is that your 5/160ths is only 3% of your total capital. If you stay invested and just take 3% a year, the odds are surely in favour of the total return over the 12 years being rather higher. The cash you have realised will not grow to any extent. There may be a market setback or two in that 12-year period but, evenso, the TR ought to be in the range of 7-10%. My own TR over the 12 years since end of 2005 has been 8.8%, which includes the "Great Recession".

I think that you are doing the equivalent of stockpiling canned food.

TJH

[tjh290633]

My real point is that your 5/160ths is only 3% of your total capital. If you stay invested and just take 3% a year, the odds are surely in favour of the total return over the 12 years being rather higher. The cash you have realised will not grow to any extent. There may be a market setback or two in that 12-year period but, evenso, the TR ought to be in the range of 7-10%. My own TR over the 12 years since end of 2005 has been 8.8%, which includes the "Great Recession".

I think that you are doing the equivalent of stockpiling canned food.

TJH

That's one of the main reasons I am not doing so. But I could if I wanted to. My interest in the discussion is to understand why a person would take say 4 to 5% a year from a HYP portfolio with all the capital and income fully exposed to the whims of the stock market. When I can lock into that kind of income virtually risk free leaving only the capital in the market. As I said earlier, I considered an income portfolio seriously before embarking on the strategy I ended up with.

But you have ignored the risk of inflation. The real value of your 5/160ths could be halved by the end of your 12 years.

TJH

[Itsallaguess]

My interest in the discussion is to understand why a person would take say 4 to 5% a year from a HYP portfolio with all the capital and income fully exposed to the whims of the stock market.

When I can lock into that kind of income virtually risk free leaving only the capital in the market.

But given the above, it seems to me like you're wanting to use the market-argument both ways.

You're pointing at a 60% gain in your portfolio over an 18-month period, and looking at the opportunity of taking that 60% out of the market, in the form of 12-years worth of 'banked income'.

You're then asking why it should take 12-years for your 'next' 60% gain to materialise, alluding to the fact that it simply 'will', and you can then rinse and repeat your 'strategy'.

In the mean-time, you're asking why someone else would only take 4% or 5% a year from a HYP, whilst exposing themselves to the market during the whole of that period.

It seems to me that your 'strategy' relies on the very thing that you're trying to avoid.....

Also, can you not see that during your next 'rinse and repeat' phase, where you've got a 12-year period for your 'next 60% gain' to materialise, and where your strategy very much relies on that happening, that such a market-rise would generally also affect the fully-exposed HYP during the same period?

Meanwhile, you're busy spending your capital that's stuffed in the mattress.....

Cheers,

Itsallaguess

[hiriskpaul]

divide your pot into two. One pot containing very low risk, low volatiltiy assets ... The other pot contains the risk assets, mainly shares. Income is drawn from the low volatility pot. Dividends from the risk pot are reinvested. When the inflation adjusted value of the risk pot has risen by 20%, 20% of the pot is sold and used to top up the low vol pot. If the income pot is exhausted, the strategy then moves on to drawing down from the risk pot. ...
Best practice for the risk pot is to make it internationally diversified, but otherwise pile it high with risk - overweight value, small caps and emerging markets.

Just a variation of rebalancing. Calendar/tax yearly back to target weightings, or a more variable choice that could at times see % stock relatively rise or decline below target weightings. Would wash overall.

As to maximising diversification between low and high volatility, Zvi Bodie takes that to the extreme, 10% 10x stock equivalent (via long dated Options (LEAPS), 90% low volatility/safe. You can dial that up or down however, through 50/50 less volatile/safe, down to 90/10 mildly risky/safe. Again to similar effect/reward on a overall risk adjusted basis.

Personally I prefer less in more volatile Small Cap Value than total stock market myself. Since 1927 SCV has been around 1.3 times as volatile than TSM. Double that up with 2x leverage and for say 34% target weighting = x 2 x 1.3 = 88 TSM equivalent. If the remainder 66% is in safe bonds then 34 generally covers the leveraging of 2x SCV borrowing cost, leaving 32 bonds. I mentally approximate bonds as being 0.5x stock, so 32 bonds compares to 16 stock. Summed with the 88 = 100% stock equivalent near-as. Given two options, 100% stock or 34% in 2x SCV, 66% bonds and I prefer the latter. As deferring rebalancing to say calendar years to give some breathing space has 2x daily leveraged funds having the characteristic of relatively attenuating (slowing) declines, amplifying gains due to compounding effects (initial 50/50 that sees a decline to 25/50 has shifted from 50/50 weightings to 33/67 weightings during the decline; 50/50 that rises to 75/50 is holding 60/40 weightings). Which can be beneficial. Compare this yearly rebalanced https://tinyurl.com/y722dmfa with adjusting its rebalance frequency to quarterly (using one of the drop down boxes near the top).

Another of the reasons I like leverage is that you can adjust the volatile holdings without having to touch the safe holdings. If bonds are tied up for a year and you want to shift exposure from 100K long stock held as 50K in 2x, to 120K long stock perhaps because stock prices had declined, then selling 20K of 2x to buy 20K of 3x gets the job done without bond liquidity issues.

Yet other benefits are reduced counter party risk (gilts are backed by the state who can increase taxes or print money rather than default and unlike bank protection limits are (within reason) unlimited protection). Also there's the in isolation tendency for leveraged products to decay by around the cost of borrowing they employ to provide leveraged exposure, such decay when held in taxable can generate tax loss harvesting benefits (reduce tax liabilities elsewhere).

The book tests and compares many draw down/rebalancing strategies. Somewhat surprisingly, this one did the best, with a good combination of safety and high income, average 6%. It differs from other strategies in 2 respects. 1) asset allocation can fly all over the place; 2) equities are never purchased, except for dividend reinvestment, only sold.

[Howard]

Perhaps a slightly controversial opening post here -

I am guilty of being rather slapdash/lazy at keeping statistics on my investment portfolio(s). Many here seem exceptionally good at that over multi years or even decades. I applaud that. But -

Given that we invest for wealth enhancement that we can live off and spend as we choose I reflect that since I moved my portfolio from HL to II in June 2016, the portfolio value has increased by 60%. Much of this reflects the general market tail wind and the 60% gain is mainly capital appreciation from a small number of funds and a small number of shares.

If I cash in the 60% gain and choose to spend it, it will last me for 12 years spending it at a rate of 5% a year. My portfolio remains intact and can fall/rise at the whim of the market but the "income" would be sitting in the bank, ready to spend.

Why would I choose an income strategy at the present time over my total return strategy? Discuss -

PS - I do not intend this to be a troll-like thread. I am really very interested in hearing what others of a different persuasion make of this.

Dear Fred,

I think you are raising a philosophical question, which in the end only you can answer. And at the moment you appear convinced that a TR strategy is best for you.

You have knowingly started a “Top Gear” type of discussion. Just like Jeremy Clarkson who tried to wind up the Hamster by stating that Ferraris are better than Porsches. Or that travelling from Bordeaux to Hampstead in a McLaren is faster than James could do it in his plane. Usually Jeremy won the argument, but only because he made up the rules.

Like you I’m not a details person and I’m a few years older. Back in my youth I invested in dotcom companies and turned a very substantial investment of 100 units into more than 400 units in less than five years.

As a complete amateur, I was amazed at how much better I had done than many professionals. But I knew luck had something to do with it.

Come the end of 2000 my portfolio had “lost” the value of a substantial house. My total return was looking a little “sick”. For years, I wished I’d sold some gains at the end of 1999 and bought a Ferrari and a Porsche. I could have settled the Top Gear argument in my own mind and the depreciation on the cars would have been miniscule compared with the drop in my portfolio.

Years later, having built the portfolio back, helped in no small measure by HYP style investments and their dividends, I have taken the decision to increase the cash portion of my investments substantially and currently have around 25% in cash or similar. This could be used to buy shares after a drop in the market or I could make that automotive investment.

My suggestion is that you have to decide what is right for you. None of us can decide what is the best strategy for others. We all have our own style.

My only “advice” is that substantial diversification is a good idea. My flutter on BooHoo shares bought at less than 51p in April 2016 compares favourably with your recent returns. However, because of my 2000 experience, I cautiously sold many of them a few months ago at over £2 each and invested the proceeds in diversified HYP style companies because I know they are “safer”.

Forgive a philosophical conclusion, but the best “guaranteed to succeed” Total Return investments have been in my children and in some charitable donations where I have been able to influence the use to which they have been put. The return from these has been much better than any portfolio or automotive experience and they are showing signs of growing a thousandfold. No one would be able to persuade me that they have a better strategy!

regards

Howard

[GeoffF100]

Income is drawn from the low volatility pot. Dividends from the risk pot are reinvested. When the inflation adjusted value of the risk pot has risen by 20%, 20% of the pot is sold and used to top up the low vol pot. If the income pot is exhausted, the strategy then moves on to drawing down from the risk pot.

The problem here is that the stock market may go down, and keep going down. You then have to live off just your safe pot. Your are safe if that remains safe, and you can live off it for the rest of your life. An index linked annuity would do the job here, but only if the provider remains in business, and the government does not default on the index linked bonds used to back the annuity. Of course, that is exactly what people want to avoid with these draw down systems. Caveat emptor.

I have poured lots of cold water. What do I suggest, for someone who is not so rich that they can just buy loads of everything?

(1). Make sure that you have a full state pension, and buy more of it if you can do so on favourable terms.

(2). Learn to live comfortably and happily within the state minimum income guarantee.

(3). If you have a house, you can generate income from that, if needs be, e.g. to pay for care (you may have no choice anyway).

(4). Your main remaining risk is the domestic government and the domestic market, so invest any remaining capital internationally.