TR versus HYP (income strategies)

[vrdiver]

Firstly, congratulations on your 60% increase.

To answer (or try to answer) your question why some of us would (do) choose an income strategy, consider the following:

What would happen if, instead of a 60% gain, you suffered an initial 25% loss and still needed to draw 5%? That 5% would take you down to 70% of your original capital. The sequence of gains and losses in a TR/sell-to-fund-living is incredibly important and not all investors will get the right start!

Secondly, unless the capital has appreciated unevenly (which might be true if e.g. equities did well, but gold and bonds didn't) selling might incur multiple costs so as to keep a balanced portfolio. Selling would also be a forced activity (assuming you don't bank the 60%, but leave what you don't need in the market).

The income strategy solves the forced selling problem. Dividends tend to be less volatile than capital, but they will fluctuate, so in both strategies the sensible investor is going to have a cash reserve anyway.

For me, the real answer is self-doubt. I don't think I could run a multi-year trading strategy, so prefer LTBH, and income is the lazy way to harvest the gains, rather than deciding what to sell or how much.

In your specific case, at this point in time, why would you withdraw the 60% gain from the market? Do you think there is a correction coming? If not, will you be upset if your 60% loses its purchasing power as the market (and inflation) continue to rise? If you do think there's one coming, then why only withdraw the profit? Why not protect the capital? Such questions become too "crystal ball gazing" for me, so I prefer to leave the capital and ignore the market peaks and troughs, take the dividends and get on with more fun stuff, but I fully see why some might enjoy the challenge of managing TR, and will probably increase their wealth faster (or lose it faster) than sticking to a more pedestrian income-based strategy.

[TahiPanasDua]

To answer (or try to answer) your question why some of us would (do) choose an income strategy, consider the following:

.

My own thoughts in a nutshell! Well said.

TP2

[Itsallaguess]

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.

Yes, I am 100% certain there is a major correction coming. Likely a 40 to 50% correction too.

The only question is when it comes. Tomorrow, ten years time? No idea.

History shows the market would probably rebound in anywhere between 6 and 24 months though.

Meantime, my income pot would be sitting in the bank, unaffected.

If you're content that any correction might be rectified in 24 months, why would there be a need to remove 12-years worth of income now, to cope with that? Wouldn't three-years worth of income suffice, with some margin to spare?

I completely understand the sentiments where we convince ourselves that there's a large correction looming, and for the record I've built up a relatively large cash pile myself over the past 18 months or so, with similar nervousness regarding the state of the market and a large number of influential political and financial unknowns currently being played out, but by doing so I've allowed myself to stay fully invested regarding my equity holdings, and will continue to do so now that I know I've got plans in place to take advantage of any major correction should it occur.

I will also now continue to invest in the current market, with any new dividends or fresh capital over and above the 16/17% cash-buffer that I've built up, leaving that buffer to act as the safety net if/when the inevitable correction comes.

That said, I'm also still working, and will hopefully continue to do so for some years yet, so this also removes some of what I might otherwise see as a more pressing 'need' to protect capital, if I were nearer retirement or similar time of life where I might need guaranteed income from investment sources.

This is the real danger of asking questions like this on an investment board - whilst you may get many different answers from people, you also really need to know much more about their personal circumstances to both fully understand their approach, given where they themselves might be on their 'life' and 'investment' journey, and you also need to understand where their personal situations might differ from your own, so that any ideas or advices might simply be incompatible with your own situation.

The danger, of course, is that whilst a correction might come (will come...), we've no real idea with regards to the timing of it, so we must hedge our bets accordingly.

It's interesting that you say that the 60% gain that you're wanting to 'protect' has come since June 2016 -

I reflect that since I moved my portfolio from HL to II in June 2016, the portfolio value has increased by 60%.

With that in mind, I just wanted to show you a thread from someone else that was 100% convinced that a huge crash was coming, which was written in November 2016 (although he was known to have written many similar doom-laden threads over an earlier period of time...I linked in the thread below to a similar TMF thread from the same guy, written in March 2015, for instance.....) -

viewtopic.php?t=1631

Given that the FTSE has never been lower, at all, since the 15th December 2016 when the above 100% crash-warning was made, it's a timely reminder that being out of the market with substantial amounts of capital for lengthy periods can be very unfortunate for our wealth -

https://uk.finance.yahoo.com/chart/%5EF ... 19fQ%3D%3D

As I said earlier, I've got similar levels of nervousness to you, and I appreciate that it's difficult to imagine the potential of watching large sums of capital getting eroded by what we might see to be an impending market crash, but I think the thread above is a timely reminder that we do need to hedge our bets accordingly, and perhaps only take the necessary precautionary actions that we need to do, rather than over-reacting and leaving ourselves open to losing out on an alternative path that the market might choose to take, regardless of our own concerns....

All the best with your decisions. Unfortunately there's no simple answer, and ultimately we must act according to our own level of comfort.

Cheers,

Itsallaguess

[GeoffF100]

History shows the market would probably rebound in anywhere between 6 and 24 months though.

Only sometimes. I suggest that you study history. Reliable US data goes back well into the nineteenth century, but only two stock markets have survived 100 years.

If you want to cash in your winnings, that is fair enough. Some investors favour rebalancing. Suppose that their portfolio consists of 50% equities and 50% bonds. If their equities rise 60%, they sell half of that gain and use the proceeds to buy more bonds, preserving their bond / equity ratio.

If you are invested in 100% equities, you are taking a big risk. A common rule of thumb suggests that you make your bond percentage the same as your age in years, but that is only a rule of thumb.

[richfool]

Fred, I see the point in terms of capital gains, as simply as: what Mr Market gives, Mr Market can very quickly take away. Whereas dividends once paid can't be taken away. In the event of a major market fall, it can take a long time for them to recover or that gain to be reacquired.

I run mainly an income focused portfolio, but do include a mix of growth stocks/IT's. I am not dependent upon the income.

In fact, if I see a holding with a particularly large gain and am worried about a market correction (or a fall in the SP of that particular stock), which could take that gain away, then I sometimes top-slice my holding, selling perhaps 25% or 33% of it, to thus consolidate some of that gain. I would probably then top-up my income producers with that gain.

[richfool]

In just 18 months of TR I have generated 12 years worth of 5% income. I "could" (but won't) draw it out and spend it over the next 12 years. Let the market then do what it wants for the next 12 years with zero worry about either capital value or a secure income stream. How many purely income focused strategies have achieved the same or better?

Fred, You refer to 18 months of TR generating "12 years worth of income". Presuming most of that has arisen from capital growth (or whatever part has arisen from capital growth), if you leave that accumulated gain in the market, it will be vulnerable to market corrections and could be wiped out. So your following comment about leaving the market to do what it wants for the next 12 years with zero worry isn't correct, unless you have removed those funds/gains from the market.

[Itsallaguess]

Thanks Itsallaguess , I think you are misreading my intentions here. I said I am certain the big crash is coming sometime between tomorrow and the next ten years. I think it rather odd that you'd apparently take an issue with that to be honest.

Well 'taking an issue with it' seems to be a much harsher interpretation of my post than I intended, so if you've read it that way then it wasn't the impression that I wanted to give....

I hope you'll also see in my post that I didn't refute your view that a market crash will occur. To do so would be ridiculous, of course, and it's almost given as fact that one will at some point, and probably soon.....

I was simply trying to ask why, if you also think a rebound would occur within a couple of years at the most, why you'd necessarily feel the need to take 12-years worth of income out.... My question was to probe your thinking, rather than criticise.....

I also wanted to point out the real dangers of being out of the market for long periods due to the idea that a big wipe-out is on the horizon. If I had listened to the various 'ring-ring' threads linked to earlier, and acted on them in any meaningful way, I'd have lost an awful lot of money that's subsequently been made by taking a much more reasoned approach....

What I am trying to think about is why so many folks here are so hung up about dividends when there is another, perhaps better way.

I think the answer to that specific question is that in general terms, income in the form of dividends is much less volatile than capital values during periods of market upheaval....

Whilst there are record-keepers on these boards that can show that their income from dividends has taken big hits for periods of time during similar volatile periods, they also show that they recover relatively quickly, and that a couple of year's worth of income-reserve can generally cope with the type of volatility seen during big market hits in the recent past.

That's speaking generally, of course, and we don't know that the next market crash, or the causes behind it, will be anything like previous ones seen...

With all the above said, I'm a huge advocate of listening to our own investment personalities during these periods of great doubt, and I think that if there's a large conviction to protect capital, and that by not doing so there would be a level of emotional toil involved, then I do think that to potentially lose some further investment gains, at the same time as benefiting from a better night's sleep, is of course sometimes the right path to take....

Cheers,

Itsallaguess

[richfool]

Yes, that's the case. I "could" (but won't) draw the capital gains and use it as income. It would be secure and guaranteed (unless HMG goes bankrupt!). It which case, yes, let the market take its course with the capital. That's also the basis of an income portfolio, only without the 12 years of already secured income in the bank. So, how is the income strategy superior in any way to the TR strategy?

Fred, Your reference to your gain being "secure and guaranteed" is confusing me. I understand your point that you are saying the TR (mainly capital gain) has generated (the equivalent of) 12 years worth of income, but that (gain part) isn't protected, - it isn't "secure and guaranteed", - so if you leave that gain in the market, (which is what you seem to be saying), you could lose (it and thus) some or all of the "12 years worth of income" in a market fall. Or is that portfolio/gain invested in bank deposits or similar.

[Itsallaguess]

If I took my profits as my income pot (I'm not going to) I would have secured my income at a rate of 5% a year for 12 years.

By spending your capital...

Cheers,

Itsallaguess

[Itsallaguess]

Which neatly encapsulates my position that really, there is no difference between income and capital.

When it comes to spending it, it is just "money".

I don't think anyone would have any disagreement with that fact with regards to the spending of it, but I think where the TR/Dividends discussions will differ is on the generating of it....

To generate it from equity sales, it will usually entail the seller making some possibly crucial decisions both in terms of what to sell and what to keep in the market. On top of those decision-making processes, that many people are reluctant to make due to the fact that it opens us up to getting some decisions wrong, there will also usually be some costs involved with gaining access to money using this method.

Generating it from income generally removes both of these issues.

Taking the above into account, along with the previously discussed volatility difference between capital and income during periods of market turbulence, there starts to enter a real difference between income and capital, depending on how it's generated and what we do with it.

Cheers,

Itsallaguess

[Itsallaguess]

It's really very easy. I simply top slice my 60% TR gain, across the board, a once only transaction.

Then I spend the money at a rate 5% a year for 12 years. Achieving that from a TR investment in 18 months, I do not see that as even possible from an income portfolio.

So, how is an income portfolio a superior strategy?

Well firstly I've not said it's a 'superior strategy', I've just highlighted some differences....

Those differences might be important to different investors, and they are important enough for me to prefer an approach that is more related to generating income from dividends, rather than relying on the sale of the investments generating them.

Cheers,

Itsallaguess

[vrdiver]

I simply top slice my 60% TR gain, across the board, a once only transaction. Then I spend the money at a rate 5% a year for 12 years. Achieving that from a TR investment in 18 months, I do not see that as even possible from an income portfolio. So, how is an income portfolio a superior strategy?

In your scenario (a one-time "take" of 60%) may make sense, but it's not the same as most people's understanding of a TR scenario!

In the general case, a top slice across the board would consume capital from your winners (as planned) but also from any losers (thus compounding the losses by selling when the price is depressed). Such a strategy would quickly distort a balanced portfolio into something with much greater risk.

Based on the above, a TR investor, in general, needs to be quite subjective in their decisions about what to sell, even if they have chosen a mechanical approach as to when to sell.

I don't think how is an income portfolio a superior strategy? is necessarily the right question. In your specific scenario you are not proposing a strategy but rather a one-time opportunistic lock-in of market gains. I might pose the same question for Income seekers as "why shouldn't I sell my increased-in-value-low-yielders and reapply that 60% of my portfolio into current high yielders? Such a proposal would then suggest that the increased dividends would provide further cushioning against a market correction, and increase the holder's long-term comfort.

Both paths are IMHO, valid, but in defence of the income yielder, top-slicing such winners may well be "baked in" to the strategy, whilst only ever withdrawing dividends from the market, whereas the TR path requires a bit more involvement re determining what is classified as income and what is re-allocation of capital back into the market.

[Alaric]

So, how is an income portfolio a superior strategy?

If inflation takes off, you are going to need to earn something on that cash. Wind yourself back 50 years and ask how wealthy an investor in 1968 who sold 60% of their assets for cash would look in 1978. Mind you the fully invested income seeking counterpart has to get past 1974.

[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

[Itsallaguess]

I simply top slice my 60% TR gain, across the board, a once only transaction.

Then I spend the money at a rate 5% a year for 12 years.

Achieving that from a TR investment in 18 months, I do not see that as even possible from an income portfolio. So, how is an income portfolio a superior strategy?

In your specific scenario you are not proposing a strategy but rather a one-time opportunistic lock-in of market gains.

And it's quite rightly a difficult thing to discuss in terms of anyone saying that it might be the 'wrong thing to do', but what I can say from my own perspective, if I were to contemplate carrying out a similar approach, would be to think that the 'Year-1' cash is going to get spent rather quickly over the next 12-months, so it might not be subject to too much influence in terms of instantly losing value over that period due to inflation etc.

But when we look further out, at what then happens to the 'banked' cash budget for subsequent years, it may of course potentially be just stuffed in the mattress, losing value in inflationary terms from day-one of extraction from the market.

When the Year-12 income is taken from the mattress, it's been sat there for a very long time, with no opportunity for appreciation, and every influence acting negatively on it from day-one....

This aspect shouldn't be neglected when thinking about such an approach.....

If thoughts then turn to the idea that 'something' could be done with the funds to minimise the impact of the above, then we're back to looking for alternative investments opportunities, which might introduce risk in itself over and above buying low-return Government-backed instruments.

I don't want to knock that approach too much, having just moved some medium-term cash into the 2.2% NS&I Guaranteed Growth Bonds discussed elsewhere recently (https://www.nsandi.com/guaranteed-growth-bonds), but in the current inflationary climate, I know these are still 'losing money', but doing so in a way that's less than when compared to being stuffed in the mattress....

Cheers,

Itsallaguess

[vrdiver]

A pure income strategy can't match this kind of return.

Now there's faith for you! Take a look at the FTSE 100 at January 1st 2000 and again at 2010 (I'll save you the effort: 6535 and 5500 reading off a chart...) Our TR player might have been looking rather enviously at the income investor over that period!

Of course, you can come right back at me with a different starting point on the graph ( ). The argument I'm proposing is a refutation of the general case you make, whilst fully accepting the specific instance you describe.

[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!

[Itsallaguess]

A pure income strategy can't match this kind of return.

Now there's faith for you! Take a look at the FTSE 100 at January 1st 2000 and again at 2010 (I'll save you the effort: 6535 and 5500 reading off a chart...) Our TR player might have been looking rather enviously at the income investor over that period!

Of course, you can come right back at me with a different starting point on the graph ( ). The argument I'm proposing is a refutation of the general case you make, whilst fully accepting the specific instance you describe.

I think this is a key point to this whole debate.

It seems that Fred is proposing a long-term strategy based on what seems to be an opportunistic time to take profits after a good market run, which of course is extremely unlikely to last.

It's very difficult to refute a 'take-profits' approach, but that doesn't mean a long-term income-strategy can be based on it, given that the market is unlikely to behave in the same way in the future. Even if it does, the time-scales involved in each cycle and sub-cycle is almost guaranteed to be different...

Income-related players know that markets will rise and fall, and hope that their income is less volatile than capital values, and these circumstances have been known in the past market-cycles (although, admittedly, are not guaranteed to re-occur in the same way in the future..), and cope with the known income-related cycles by ensuring that they hold income-reserve that is likely to be enough to ride out the income-related impacts of those cycles.

Cheers,

Itsallaguess

[GeoffF100]

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

In the long term, this has not been true, even in the stock markets that have survived. There have been several periods in which dividends fell by 50% or more and took 20 years or more to recover.

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.

The long term equity risk premium has historically been about 3 to 3.5%:

https://papers.ssrn.com/sol3/papers.cfm ... id=1940165

Long term gilts are currently yielding less than 2%. Adding the equity risk premium, gives an expected long term equity total return of about 5%, but stock market valuations are currently high by historical standards, so this may be optimistic.

[Itsallaguess]

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.

So long as you accept that you're trying to base a TR 'strategy' on what's really a TR 'opportunity', and that you're then comparing that 'opportunity' with a long-term income-strategy, which might not be as fair a comparison in this instance as we might rightly expect....

Also, when you say 'I can think of no circumstance where a pure income portfolio can achieve this outcome', how hard are you thinking?

What if dividends generally doubled over the next three years, and steadily grew above inflation for the next nine years?

If that happened, might it go some way to achieving a similar outcome?

I don't know the answer to that, and I doubt it might happen, but then 18 months ago you may have doubted that your 100 might have grown to 160, but it has, and it's created the opportunity that's presented itself to you.

That doesn't mean you can base a long-term strategy on that opportunity though, does it?

Or that it means a single beneficial capital-outcome can be used to write off a different type of long-term strategy, does it?

What if a bitcoin investor came here and tried to dismiss both equity-TR and equity-income strategies based on their last 18-months performance, would you think he would have a valid case to promote his 'long-term strategy' at the expense of those others?

If not, why not?

Cheers,

Itsallaguess