Gengulphus wrote:...
Those calculations are rather simplistic - for instance, they don't take inflation into account - but give the general flavour of what happens for one scenario. That particular scenario is not too far from what happened to my own HYP during the financial crisis about a decade ago - its dividend income dropped by about a third in a year and with a bit more allowed to compensate for inflation, 40% is probably a bit more of a drop than it experienced. Just how quick the recovery was, I don't really know (*) but the schedule above doesn't seem too unreasonable.
To do the job properly, I would want to check out a few different scenarios - a prolonged period of high inflation with dividends taking quite a long time to start rising in line with inflation might be another, for instance. But generally speaking, I would always want at least some safety margin of the HYP-generated income over the income I actually required, to give a decent hope of replenishing the cash reserve afterwards if I did need to use it and to deal with something going wrong long-term: for an indefinitely-long impairment to the HYP's dividend income, the protection given by such a safety margin will last indefinitely, whereas any cash reserve will eventually dwindle to zero.
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... it's important to consider multiple scenarios of what could go wrong and get a good balance of dealing with all of them.
(*) I was still building it up with capital from other sources for some time afterwards, so it would need to be unitised for me to get a proper idea - and I'm not even going to attempt retrospective unitisation that far back!
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When attempting to "consider multiple scenarios" it is usually things like falls in dividend payments due to something like the financial crisis and/or unexpectedly high inflation that are, at least for me, the first adverse effects on income that come to mind. If someone is going to follow your advice though and consider multiple scenarios then one another potential income-impacting event that some might want to consider is further changes in the tax treatment of dividend income. In the UK we have already seen the change from the tax credit scheme to the (diminishing) tax-free dividend allowance plus 7.5%/32.5%/38.1% tax rates which, at least for me, resulted in a noticeable hit on my net income once I had made the necessary upward adjustment to my monthly tax accrual.
Future unannounced tax changes are impossible to forecast of course but if trying to analyse various income fall scenarios I think the possibility is worth remembering. Personally I have modelled what the effect would be on my net income were dividend taxation to be fully aligned with the current PAYE tax scheme, i.e. 20%/40%/45% with the same banding and the separate dividend tax allowance totally abolished. I'm not suggesting that would happen but it is the "worst-case"(*) tax scenario that I model.
(*) "Worst-case" in quotes because it is of course by no means the worst possible case. Something like NI getting merged with basic income tax and dividends falling under that scheme could result in the rates being higher than 20%/40%/45%, or almost certainly even worse a move back the the 1970s "tax them until the pips squeak" era that I think resulted in dividend tax rates up to 98% (or pretty close to that). I'm not trying to make any political or moral points and anyone who wants to model any possible adverse tax effects would have to choose their own "worst-case" scenario to model, but some might want to consider it.
- Julian