High yield vs other investing strategies

[IanTHughes]

I think one should be critical of stock selection approaches that ignore the possibility that the dividend is in effect just a return of capital. A recently selected stock in a "HYP" example portfolio has already shed something like 5% or more

Hold the presses! They were right! Share prices CAN GO DOWN. And to think, I was there when it happened! I shall have some story to tell the grandkids!

Seriously, that share price movement over a period of about a week is completely MEANINGLESS. Anyone who thinks otherwise should probably not invest in Equities, period.


Ian

[Alaric]

Seriously, that share price movement over a period of about a week is completely MEANINGLESS.

Believe that if you want, but personally I regard a yield of 9% on a near utility as "too good to be true". By waiting a week or two, the yield went even higher.

[Gengulphus]

But I think it would be a mistake to think that the risk of management largesse only exists with regards to income-investment strategies - it's likely that boardrooms across the investment-strategy spectrum are little different to one another in that regard...

I think one should be critical of stock selection approaches that ignore the possibility that the dividend is in effect just a return of capital. A recently selected stock in a "HYP" example portfolio has already shed something like 5% or more of its supposed 9.5% yield by way of capital loss. Particularly if intending to adopt a "buy and hold" strategy, for those stocks where the dividend yield is too high to be true, it probably is in total value terms.

Agreed about cases where the dividend is in effect just a return of capital, provided that's judged on whether the company is shedding the capital value and not on whether the market is shedding its shares' capital value. The two can differ wildly, an obvious case being what happened to miners a few years ago. Judged by what the market did to their shares, Rio Tinto and BHP Billiton (as it was then named) shed huge amounts of capital value in 2015 - and then 'unshed' all of it in 2016. And that is IMHO an utterly and completely ridiculous portrayal of what was actually happening to the capital values of the companies themselves in those two years: behemoths as big as them simply don't change their capital value as companies that wildly, and what the share price showed was instead the market's views on the companies changing wildly.

That wouldn't saved you if you'd decided to accept the market's valuation by selling the shares in January 2016, of course, nor would it have prevented you from making a major gain by accepting it and buying the shares then. But it does IMHO practically prove that at the time, the market's views on the shares' capital value were a long way from reflecting the company's capital value for any purposes other than an immediate trading decision. I've seen other such cases where the discrepancy is just as obvious, including at the end of 1999 when it is probably even more obvious that the market was valuing tech shares far above and "old economy" shares far below the companies' capital values, and I see little reason to believe that similar, smaller but still very worthwhile discrepancies are anything like as rare as the ones that are really obvious.

The trouble is that while the market's view on the shares' capital value is very easy to assess, the company's capital value is not - and even on the fairly rare occasions that the discrepancy is large enough to be obvious, it's usually only obvious with hindsight. The only one I regarded as obvious at the time was the discrepancy about tech share and "old economy" share valuations around the end of 1999. So I'm not saying that it's at all easy to use the capital values of companies rather than the market-assigned capital values of their shares, just that it's the former and not the latter that actually matters for LTBH strategies (including both high-yield and non-high-yield ones).

And in general, HYP strategies do make an attempt to assess the companies' capital values - the idea that all they care about is the dividend yield, regardless of anything else, is a caricature. Many of them (including pyad's original HYP strategy) look at the company's debt situation, which is most certainly related with its capital value. Unfortunately, it's a caricature that opponents of HYP strategies love to seize upon and attack - it's so easily shot down! - and that supporters of them tend to end up encouraging in the pursuit of succinctness. E.g. "capital doesn't matter" is a lovely short soundbite - as long as its audience doesn't take it literally. (And yes, there probably are some HYPers who do take it completely literally - but what I see much more often is that people manage to overlook qualifications such as that in "I buy the share with the highest yield that meets my other criteria".)

Gengulphus

[Lootman]

the market's views on the shares' capital value were a long way from reflecting the company's capital value for any purposes other than an immediate trading decision. I've seen other such cases where the discrepancy is just as obvious, including at the end of 1999 when it is probably even more obvious that the market was valuing tech shares far above and "old economy" shares far below the companies' capital values, and I see little reason to believe that similar, smaller but still very worthwhile discrepancies are anything like as rare as the ones that are really obvious.

I had a similar insight at that time albeit via a different path. At the time one of my responsibilities at the IB I worked at was compliance. That meant that I got to see the portfolios of everyone who worked there. And from the top to the bottom of the organisation, people were loaded up to the gills with tech shares. I could not help but feel that the end was nigh.

I did not short them as a result (I would have been barred from so doing in any event). But I did scale back my personal Tech holdings to something that was very manageable when the fan was excremented.

in general, HYP strategies do make an attempt to assess the companies' capital values - the idea that all they care about is the dividend yield, regardless of anything else, is a caricature. Many of them (including pyad's original HYP strategy) look at the company's debt situation, which is most certainly related with its capital value. Unfortunately, it's a caricature that opponents of HYP strategies love to seize upon and attack - it's so easily shot down! - and that supporters of them tend to end up encouraging in the pursuit of succinctness. E.g. "capital doesn't matter" is a lovely short soundbite - as long as its audience doesn't take it literally. (And yes, there probably are some HYPers who do take it completely literally - but what I see much more often is that people manage to overlook qualifications such as that in "I buy the share with the highest yield that meets my other criteria".)

I think the jury is still out on HY strategies, at least if the concern is cashflows and total returns. I see the appeal of something like HYP if you want larger returns sooner, perhaps because your life expectancy is limited (as reflected by the annuity analogy). Or because you do not otherwise have enough to retire on.

But I do not believe and am yet to be convinced that HY investing is anything other than an acceleration of returns rather than an enlargement of them. Nor that risk is not elevated as a result.

[SDN123]

I think the jury is still out on HY strategies, at least if the concern is cashflows and total returns. I see the appeal of something like HYP if you want larger returns sooner, perhaps because your life expectancy is limited (as reflected by the annuity analogy). Or because you do not otherwise have enough to retire on.

But I do not believe and am yet to be convinced that HY investing is anything other than an acceleration of returns rather than an enlargement of them. Nor that risk is not elevated as a result.

I think this is the best summary I’ve seen so far of the challenges of the HYP approach.

Personally I’m still saving / investing and, as part of that, running a “trial” HYP. So far i’ve made mistakes but despite that find that the approach suits me. HYP feels comfortable to me because:

- HYP is simple enough to understand although there is enough complexity to keep me thinking (which I enjoy - the learning curve and the delusion of control);

- HYP is basically LTBH (which I believe is a slim advantage for a PI over professionals);

- HYP is very cheap to run once the portfolio reaches a reasonable size (which I believe is a slim advantage for a PI over professionals);

- there is a lot of scope to vary drawdown % on retirement to match my personal circumstances. I expect to need somewhere between a 3% drawdown rate (safe-ish) and 5% (very risky) - both safely within typical HYP natural yield rates.

- there are no selling decisions associated with drawdown (and so far I’m terrible at selling);

There are some “false” (eg misleading) benefits:

- there are no inherent costs in drawing down (dividends come free, selling includes a fee). But, of course, if I reinvest some of the income there ARE running costs - buying fees plus stamp duty.

- I have no doubt that total return and capital values matter, it is possible that over my investment / drawdown timeline high yield turns out to be les than optimal for TR but it is also possible it turns out to be a great approach. I can’t know which is best for me until it’s too late!

- Tax situations are too personal to help differentiate between strategies.

So, in summary, HYP feels comfortable to me, not enough that I’m using it for my main savings strategy but comfortable enough that it’s still my plan for retirement drawdown.

Churchill may have said “Democracy is the worse form of government, except for all of the others.”

For me, for the reasons above, “HYP is the worst retirement drawdown strategy, except for all of the others.”

My opinion may change if:
- I end up much richer than expected;
- I end up much poorer than expected;
- there are major changes in tax laws (income tax vs CGT; ISA rules and/or pension rules);
- there are major changes in my understanding of other strategies.

For this last reason I find LF, and specifically this thread, both useful and entertaining.

SDN

[Dod101]

Since we are throwing complements around, I think that SDN's comments are about as good a summary of the HYP strategy as I have read for a long while. He also says that it is not his main savings strategy whilst he is not drawing on his HYP. I have never seen it as a particularly good total return strategy (which is what anyone building up funds for retirement should really be aiming for I think), certainly not in recent years where 'defensive' shares (that is most of the usual suspects for a HYP) have been out of favour.

I have been living off my dividends for more than 20 years but have always had a small portfolio of growth shares and ITs running alongside my high yield portfolio (it is not a HYP as per the hallowed definition of the HYP - Practical Board) simply so as to try to get some exposure to capital growth rather than income.

Dod

[tjh290633]

I started to move towards income-based investments in the early 1970s, having been mostly in more growth oriented investments up to that time. That decade confirmed my view that a higher income gave better total returns than did investing for growth with a lower income. I ran both methods in parallel up to the 1990s, much of it in collective investments, but the advent of PEPs in 1987 propelled me towards individual shares.

There are times when "growth" shares do better, but over the long term the "income" shares win the battle. I still have some OEICs in the income category, which serve as a useful check of the performance of my equity portfolio.

As we all know, there are an infinite number of approaches to investing for income. Which route one follows will depend on personal preference and circumstances. I am comfortable with my own approach to the HYP principles. Others might prefer to use Investment Trusts or ETFs for the purpose. There is no correct answer.

TJH

[Gengulphus]

There are some “false” (eg misleading) benefits:

- there are no inherent costs in drawing down (dividends come free, selling includes a fee). But, of course, if I reinvest some of the income there ARE running costs - buying fees plus stamp duty.

Some care needed there, I think, about the difference between running costs and setup costs. To illustrate the principle in an investment with considerably less variability to muddle one's thinking, if I were to buy a holding (in a non-HYP portfolio) of very long-dated gilts that were certain only to mature after my death, the buying costs would be setup costs. If I were later to find some spare cash and buy more gilts to add to the portfolio, the costs of that purchase would also be setup costs (and it wouldn't make any difference to that whether I happened to choose exactly the same type of gilt - i.e. whether it was a new holding purchase or a top-up purchase). In neither case would any of the buying costs be running costs. But if for instance I'd decided on a strategy of investing in gilts with 5 years to maturity, I would have to expect an average of 20% of my portfolio to mature each year, giving me cash that has to be reinvested if I want to maintain my portfolio's returns. If reinvesting them incurs buying costs of 1% of the amount reinvested, then that costs me an average of 0.2% (i.e. 1% of 20%) of the portfolio's value per year to keep it running as intended - i.e. the portfolio's running costs are 0.2% per year.

So the principle is basically that the running costs of a strategy are the recurring costs associated with keeping it running as intended. That "as intended" does of course beg the question "Just what is intended?"... And that's the key to your point: when trying to determine the running costs of a strategy, one needs to know a detail that isn't normally thought of as part of "the strategy", namely the way the investor intends to run it. Without that detail, the "running costs of the strategy" is an ill-defined concept.

In this case, it's not exactly seriously ill-defined. If I run a mature HYP without any dividend reinvestment and you run an initially-identical HYP reinvesting 20% of the dividend income, my buying costs for the buys made with dividends are clearly zero and you're making buys with something of the order of 1% (20% of a 5% portfolio yield) of the portfolio value per year, and so the buying costs for those purchases are something of the order of 0.01% of the portfolio value per year. I.e. the running costs of your exact strategy are very roughly 0.01 percentage points above those of my exact strategy. So the "running costs of our HYP strategy" is not actually a completely well-defined concept, but it is defined to within about +/- 0.01 percentage points - which I suspect most people would regard as well-defined enough!

But you're right in that HYP strategies do have running costs due to purchases - not just the ones that include dividend reinvestment in their exact intentions, but essentially all HYP strategies: the only exception is a HYP strategy run with the intention of never reinvesting any cash returned by the portfolio. That's a very odd intention for an investor to have, due especially to takeovers returning cash in very large chunks very haphazardly: HYP1 for instance has had one takeover for cash in 2001, none in 2002-2005, a total of five in 2006-2008 and none since, and those six takeovers have returned somewhere in the region of half the portfolio's value... Running a portfolio that way is basically playing Russian roulette with how much one has invested in it, so basically I would say that all even moderately sensible HYP strategies have running costs.

Roughly how much are those running costs? On a single-year basis, that same large variability in terms of how much reinvestment of takeover proceeds is needed means that the answer can only be "highly variable", so any attempted numerical answer can only really be a long-term average. And takeover proceeds are not the only form of non-dividend cash return one might very reasonably feel needs to be reinvested to keep the portfolio running as intended: corporate actions consisting of a cash distribution (usually a special dividend) accompanied by a share consolidation are another prime candidate, since the share consolidation reduces one's dividend income even if (as usually happens) the ordinary dividend per share isn't normally changed markedly afterwards. Such corporate actions generally return much smaller amounts than cash takeovers, but are quite a bit more common (I don't have the exact number for HYP1, but its most prolific user of such actions (Intercontinental Hotels) has produced more than six on its own!), so that their total effect on the portfolio's value is still fairly significant. As a very rough ballpark figure, HYP1 (which basically reinvests the proceeds of takeovers and such corporate actions, and little else) has ended up reinvesting a long-term average figure of 5% of its value per year, resulting in ballpark long-term-average buying costs of 0.05% of its value per year.

So basically:

* Yes, HYPs do have running costs - very small ones, but not zero (as a long-term average).

* Yes, whether one reinvests some of those dividends does make a difference to those running costs - but not all that much of one: order of 0.01% in running costs that are of the order of 0.05% (again, as a long-term average).

* Personally, I would regard those figures as small enough that "false" and "misleading" aren't really appropriate ways of describing claims that HYP have no running costs - "not pedantically accurate" or "not strictly true" would come closer, I think.

Finally, one caution: when comparing running-costs figures for a portfolio you run yourself with published figures about the costs of investment trusts, unit trusts, OEICs, ETFs, etc, take care to compare like with like. For example, when I last looked several years ago, "Total Expense Ratios" or "TERs" were specifically defined to exclude trading costs incurred within the underlying portfolio - so when comparing with TERs, the appropriate figure for a HYP really was zero (*). That's in the past tense because I'm not certain to what extent TERs even have an official definition any more - they've vanished from the FCA Handbook glossary, which was where I last saw one. But the following quote (with my bold) from Wikipedia indicates that it's still typically true (with my bold):

"Typically it consists of the annual management charge (AMC), the fee that the fund company charges annually to manage the fund (typically commission paid to fund managers), plus 'other' charges incurred with running the fund. These other charges can consist of share registration fees, fees payable to auditors, legal fees, and custodian fees. Not included in the total expense ratio are transaction costs as a result of trading of the fund's assets."

(*) Unless one wants to place a value on the time one has to spend on managing the HYP. Even valued at minimum wage rates, the time one spends on researching and making a decision about a single takeover replacement or a rights issue might be quite significant compared with the average trading costs incurred per year...

- I have no doubt that total return and capital values matter, it is possible that over my investment / drawdown timeline high yield turns out to be les than optimal for TR but it is also possible it turns out to be a great approach. I can’t know which is best for me until it’s too late!

Yes, indeed, "capital doesn't matter" simply isn't true. At best, it's oversimplified shorthand for "capital fluctuations don't matter", "there are lots of more effective uses for your available investment research time than looking at share price histories" or something similar. Those aren't necessarily true either, but they are positions one can reasonably take - i.e. not obviously false.

- Tax situations are too personal to help differentiate between strategies.

??? I don't see how that can be seen as a claim of a benefit of HYP strategies at all - true, false, misleading or anything else. It's basically just saying that recommendations given on a tax basis about using HYP strategies without either knowledge of the investor's tax situation or a qualification restricting it to some tax situations can be pretty misleading. For example, "non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance" is poor advice compared with "for those investors whose investments are not all in ISAs and SIPPs, non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance". Hopefully no-one would be misled by the first to the point of it actually costing them money, but those whose investments are completely tax-sheltered but who lack a good understanding of the tax system could easily waste a fair amount of time trying to work out how to get an advantage from using their CGT allowance...

Gengulphus

[Lootman]

- I have no doubt that total return and capital values matter, it is possible that over my investment / drawdown timeline high yield turns out to be les than optimal for TR but it is also possible it turns out to be a great approach. I can’t know which is best for me until it’s too late!

Yes, indeed, "capital doesn't matter" simply isn't true. At best, it's oversimplified shorthand for "capital fluctuations don't matter", "there are lots of more effective uses for your available investment research time than looking at share price histories" or something similar. Those aren't necessarily true either, but they are positions one can reasonably take - i.e. not obviously false.

If all that "capital doesn't matter" means when quoted by a HYP'er is that one should not keep checking prices and values every day, then that is fine. Although that is hardly unique to HYP. It applies to many or most LTBH strategies and probably some others too. Basically if you are not day-trading or employing very short-term strategies then it is a good idea to not overload yourself with day-to-day noise.

But the connotation of "capital doesn't matter" in this context generally means more than that. It can literally mean that the income is the only thing that matters. We see this when people say that the idea is to live off only the dividends and to never draw down from capital. And we see it when people use the "annuity analogy" for HYP. In fact not only does HYP say that you never sell to provide cash but even in some cases that you never sell to buy a better prospect.

And I think that is where the precept is subject to critical review. If you decide that you will never sell, and/or never spend or draw down the capital, then you are basically declaring that you intend to die with all that capital intact and pass it on to your will beneficiaries. And that might be a valid approach, especially for those with children whom you wish to inherit. But as an investment strategy it falls short because it effectively lowers artificially the amount you have to live off for the rest of your days.

Or put another way it means that you need to accrue a larger sum before you can retire because you cannot rely on drawdown.

- Tax situations are too personal to help differentiate between strategies.

??? I don't see how that can be seen as a claim of a benefit of HYP strategies at all - true, false, misleading or anything else. It's basically just saying that recommendations given on a tax basis about using HYP strategies without either knowledge of the investor's tax situation or a qualification restricting it to some tax situations can be pretty misleading. For example, "non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance" is poor advice compared with "for those investors whose investments are not all in ISAs and SIPPs, non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance". Hopefully no-one would be misled by the first to the point of it actually costing them money, but those whose investments are completely tax-sheltered but who lack a good understanding of the tax system could easily waste a fair amount of time trying to work out how to get an advantage from using their CGT allowance...

Historically I have taken the view that tax treatments have been a boon to HYPs, at least until recently. That is because dividends are quite lightly-taxed. That makes something like HYP more attractive to a taxable investor than it would be if, say, dividends were instead taxed at your highest marginal income tax rate. Recently taxes have been raised on dividends and that has, at least to this investor, made dividends less attractive because they are an involuntary tax event, whereas share price growth and buybacks do not create a tax event but rather allow me more control over when to pay tax and how much to pay.

It is perhaps significant that something like HYP has not caught on in the US and some other places where the tax systems are different and dividends don't get specially generous treatment. Your argument that none of this applies for investments in an ISA has merit although even there, for larger portfolios, the CGT savings within an ISA can easily exceed the dividend tax savings.

So over the years I have gone back and forth on whether my growth positions should be in an ISA and dividend shares should be in my taxable account, or vice versa. At the moment I am leaning towards putting dividends in my ISA following the tax changes of the last few years, indicating that the tax drivers behind HYP have declined somewhat.

[Gengulphus]

... In fact not only does HYP say that you never sell to provide cash but even in some cases that you never sell to buy a better prospect.

That's IMHO a rather unusual "fact", since no HYP strategy that I've been able to look at in detail and over a long enough period to see a good variety of circumstances actually follows a "never sell voluntarily under any circumstances whatsoever" principle. For example, the HYP strategy pyad uses in HYP1 has voluntarily sold United Utilities rights and Mondi, Alliance & Leicester and Ladbrokes Coral shares over the years without any actual need to sell (maybe more that I don't recall offhand). What is true is that reasonably concise, readable descriptions of some of those HYP strategies state a general "never sell" principle, but when tested properly, there are always some exceptions to that general principle.

I have of course only been able to look at the details of a fairly limited number of the HYP strategies I've seen mentioned, so maybe there are some (and some HYPers) that really do follow a "never sell voluntarily under any circumstances whatsoever" principle. But on the evidence I've actually been able to see, I think that the idea that HYP says you never sell is merely a concise-but-somewhat-oversimplified statement of what many (not all) HYP strategies say.

Gengulphus

[Lootman]

... In fact not only does HYP say that you never sell to provide cash but even in some cases that you never sell to buy a better prospect.

That's IMHO a rather unusual "fact", since no HYP strategy that I've been able to look at in detail and over a long enough period to see a good variety of circumstances actually follows a "never sell voluntarily under any circumstances whatsoever" principle. For example, the HYP strategy pyad uses in HYP1 has voluntarily sold United Utilities rights and Mondi, Alliance & Leicester and Ladbrokes Coral shares over the years without any actual need to sell (maybe more that I don't recall offhand). What is true is that reasonably concise, readable descriptions of some of those HYP strategies state a general "never sell" principle, but when tested properly, there are always some exceptions to that general principle.

I have of course only been able to look at the details of a fairly limited number of the HYP strategies I've seen mentioned, so maybe there are some (and some HYPers) that really do follow a "never sell voluntarily under any circumstances whatsoever" principle. But on the evidence I've actually been able to see, I think that the idea that HYP says you never sell is merely a concise-but-somewhat-oversimplified statement of what many (not all) HYP strategies say.

Well, Bland claims to run one fairly literally and Luniversal has sung from that hymn book as well, both just off the top of my head.

But my main point was not to argue against the "no tinker" idea (as flawed as I think that is) but rather against the "capital doesn't matter" idea as I described it.

[Gengulphus]

... In fact not only does HYP say that you never sell to provide cash but even in some cases that you never sell to buy a better prospect.

That's IMHO a rather unusual "fact", since no HYP strategy that I've been able to look at in detail and over a long enough period to see a good variety of circumstances actually follows a "never sell voluntarily under any circumstances whatsoever" principle. For example, the HYP strategy pyad uses in HYP1 has voluntarily sold United Utilities rights and Mondi, Alliance & Leicester and Ladbrokes Coral shares over the years without any actual need to sell (maybe more that I don't recall offhand). What is true is that reasonably concise, readable descriptions of some of those HYP strategies state a general "never sell" principle, but when tested properly, there are always some exceptions to that general principle.

I have of course only been able to look at the details of a fairly limited number of the HYP strategies I've seen mentioned, so maybe there are some (and some HYPers) that really do follow a "never sell voluntarily under any circumstances whatsoever" principle. But on the evidence I've actually been able to see, I think that the idea that HYP says you never sell is merely a concise-but-somewhat-oversimplified statement of what many (not all) HYP strategies say.

Well, Bland claims to run one fairly literally and Luniversal has sung from that hymn book as well, both just off the top of my head.

As I indicated, when one looks at the facts, one of the differences between HYP1 being run "fairly literally" and "literally" by that hymn book is that HYP1 does sell holdings voluntarily on occasions. As for Luniversal, I may have misspoken slightly: I haven't looked at any of his HYP strategies in enough detail, but maybe I would have been able to if I'd spent enough time on the attempt.

Also, one does need to be a bit careful to distinguish between the full version of a hymn that appears in the hymn book and the hymn that's actually sung - sometimes hymns (especially the longer ones) are sung with verses omitted... ;-)

Gengulphus

[Lootman]

That's IMHO a rather unusual "fact", since no HYP strategy that I've been able to look at in detail and over a long enough period to see a good variety of circumstances actually follows a "never sell voluntarily under any circumstances whatsoever" principle. For example, the HYP strategy pyad uses in HYP1 has voluntarily sold United Utilities rights and Mondi, Alliance & Leicester and Ladbrokes Coral shares over the years without any actual need to sell (maybe more that I don't recall offhand). What is true is that reasonably concise, readable descriptions of some of those HYP strategies state a general "never sell" principle, but when tested properly, there are always some exceptions to that general principle.

I have of course only been able to look at the details of a fairly limited number of the HYP strategies I've seen mentioned, so maybe there are some (and some HYPers) that really do follow a "never sell voluntarily under any circumstances whatsoever" principle. But on the evidence I've actually been able to see, I think that the idea that HYP says you never sell is merely a concise-but-somewhat-oversimplified statement of what many (not all) HYP strategies say.

Well, Bland claims to run one fairly literally and Luniversal has sung from that hymn book as well, both just off the top of my head.

As I indicated, when one looks at the facts, one of the differences between HYP1 being run "fairly literally" and "literally" by that hymn book is that HYP1 does sell holdings voluntarily on occasions. As for Luniversal, I may have misspoken slightly: I haven't looked at any of his HYP strategies in enough detail, but maybe I would have been able to if I'd spent enough time on the attempt.

Also, one does need to be a bit careful to distinguish between the full version of a hymn that appears in the hymn book and the hymn that's actually sung - sometimes hymns (especially the longer ones) are sung with verses omitted... ;-)

Possibly so but, again, the main thrust of my argument was about the problems with "capital doesn't matter" and not the problems with "do not tinker".

[Alaric]

Possibly so but, again, the main thrust of my argument was about the problems with "capital doesn't matter" and not the problems with "do not tinker".

It's never really been clear what level of asset value is being targeted to eventually form the estate or a possibly forced disposal for care costs. Is it the initial investment revalued by at least as much as price inflation, the original stake money or an amount whittled away to near zero by capital returns?

In the special case where the 15 or so stocks selected from the FTSE100 give the same performance as the 85 not selected, choosing by dividend yield would show a higher income but poorer capital performance that the average as measured by the index.

[SDN123]

There are some “false” (eg misleading) benefits:

- there are no inherent costs in drawing down (dividends come free, selling includes a fee). But, of course, if I reinvest some of the income there ARE running costs - buying fees plus stamp duty.

Some care needed there, I think, about the difference between running costs and setup costs. To illustrate the principle in an investment with considerably less variability to muddle one's thinking, if I were to buy a holding (in a non-HYP portfolio) of very long-dated gilts that were certain only to mature after my death, the buying costs would be setup costs. If I were later to find some spare cash and buy more gilts to add to the portfolio, the costs of that purchase would also be setup costs (and it wouldn't make any difference to that whether I happened to choose exactly the same type of gilt - i.e. whether it was a new holding purchase or a top-up purchase). In neither case would any of the buying costs be running costs. But if for instance I'd decided on a strategy of investing in gilts with 5 years to maturity, I would have to expect an average of 20% of my portfolio to mature each year, giving me cash that has to be reinvested if I want to maintain my portfolio's returns. If reinvesting them incurs buying costs of 1% of the amount reinvested, then that costs me an average of 0.2% (i.e. 1% of 20%) of the portfolio's value per year to keep it running as intended - i.e. the portfolio's running costs are 0.2% per year.

So the principle is basically that the running costs of a strategy are the recurring costs associated with keeping it running as intended. That "as intended" does of course beg the question "Just what is intended?"... And that's the key to your point: when trying to determine the running costs of a strategy, one needs to know a detail that isn't normally thought of as part of "the strategy", namely the way the investor intends to run it. Without that detail, the "running costs of the strategy" is an ill-defined concept.

In this case, it's not exactly seriously ill-defined. If I run a mature HYP without any dividend reinvestment and you run an initially-identical HYP reinvesting 20% of the dividend income, my buying costs for the buys made with dividends are clearly zero and you're making buys with something of the order of 1% (20% of a 5% portfolio yield) of the portfolio value per year, and so the buying costs for those purchases are something of the order of 0.01% of the portfolio value per year. I.e. the running costs of your exact strategy are very roughly 0.01 percentage points above those of my exact strategy. So the "running costs of our HYP strategy" is not actually a completely well-defined concept, but it is defined to within about +/- 0.01 percentage points - which I suspect most people would regard as well-defined enough!

But you're right in that HYP strategies do have running costs due to purchases - not just the ones that include dividend reinvestment in their exact intentions, but essentially all HYP strategies: the only exception is a HYP strategy run with the intention of never reinvesting any cash returned by the portfolio. That's a very odd intention for an investor to have, due especially to takeovers returning cash in very large chunks very haphazardly: HYP1 for instance has had one takeover for cash in 2001, none in 2002-2005, a total of five in 2006-2008 and none since, and those six takeovers have returned somewhere in the region of half the portfolio's value... Running a portfolio that way is basically playing Russian roulette with how much one has invested in it, so basically I would say that all even moderately sensible HYP strategies have running costs.

Roughly how much are those running costs? On a single-year basis, that same large variability in terms of how much reinvestment of takeover proceeds is needed means that the answer can only be "highly variable", so any attempted numerical answer can only really be a long-term average. And takeover proceeds are not the only form of non-dividend cash return one might very reasonably feel needs to be reinvested to keep the portfolio running as intended: corporate actions consisting of a cash distribution (usually a special dividend) accompanied by a share consolidation are another prime candidate, since the share consolidation reduces one's dividend income even if (as usually happens) the ordinary dividend per share isn't normally changed markedly afterwards. Such corporate actions generally return much smaller amounts than cash takeovers, but are quite a bit more common (I don't have the exact number for HYP1, but its most prolific user of such actions (Intercontinental Hotels) has produced more than six on its own!), so that their total effect on the portfolio's value is still fairly significant. As a very rough ballpark figure, HYP1 (which basically reinvests the proceeds of takeovers and such corporate actions, and little else) has ended up reinvesting a long-term average figure of 5% of its value per year, resulting in ballpark long-term-average buying costs of 0.05% of its value per year.

So basically:

* Yes, HYPs do have running costs - very small ones, but not zero (as a long-term average).

* Yes, whether one reinvests some of those dividends does make a difference to those running costs - but not all that much of one: order of 0.01% in running costs that are of the order of 0.05% (again, as a long-term average).

* Personally, I would regard those figures as small enough that "false" and "misleading" aren't really appropriate ways of describing claims that HYP have no running costs - "not pedantically accurate" or "not strictly true" would come closer, I think.

Finally, one caution: when comparing running-costs figures for a portfolio you run yourself with published figures about the costs of investment trusts, unit trusts, OEICs, ETFs, etc, take care to compare like with like. For example, when I last looked several years ago, "Total Expense Ratios" or "TERs" were specifically defined to exclude trading costs incurred within the underlying portfolio - so when comparing with TERs, the appropriate figure for a HYP really was zero (*). That's in the past tense because I'm not certain to what extent TERs even have an official definition any more - they've vanished from the FCA Handbook glossary, which was where I last saw one. But the following quote (with my bold) from Wikipedia indicates that it's still typically true (with my bold):

"Typically it consists of the annual management charge (AMC), the fee that the fund company charges annually to manage the fund (typically commission paid to fund managers), plus 'other' charges incurred with running the fund. These other charges can consist of share registration fees, fees payable to auditors, legal fees, and custodian fees. Not included in the total expense ratio are transaction costs as a result of trading of the fund's assets."

(*) Unless one wants to place a value on the time one has to spend on managing the HYP. Even valued at minimum wage rates, the time one spends on researching and making a decision about a single takeover replacement or a rights issue might be quite significant compared with the average trading costs incurred per year...

- I have no doubt that total return and capital values matter, it is possible that over my investment / drawdown timeline high yield turns out to be les than optimal for TR but it is also possible it turns out to be a great approach. I can’t know which is best for me until it’s too late!

Yes, indeed, "capital doesn't matter" simply isn't true. At best, it's oversimplified shorthand for "capital fluctuations don't matter", "there are lots of more effective uses for your available investment research time than looking at share price histories" or something similar. Those aren't necessarily true either, but they are positions one can reasonably take - i.e. not obviously false.

- Tax situations are too personal to help differentiate between strategies.

??? I don't see how that can be seen as a claim of a benefit of HYP strategies at all - true, false, misleading or anything else. It's basically just saying that recommendations given on a tax basis about using HYP strategies without either knowledge of the investor's tax situation or a qualification restricting it to some tax situations can be pretty misleading. For example, "non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance" is poor advice compared with "for those investors whose investments are not all in ISAs and SIPPs, non-tinkering HYP strategies are a poor choice because they don't make use of the investor's CGT allowance". Hopefully no-one would be misled by the first to the point of it actually costing them money, but those whose investments are completely tax-sheltered but who lack a good understanding of the tax system could easily waste a fair amount of time trying to work out how to get an advantage from using their CGT allowance...

Gengulphus

Hi Gengulphus,

I wouldn’t disagree with anything you say. I think the problem was my clumsy contribution. What I was trying to say was: here are the reasons that HYP is a viable option for me (the first list of issues) and and then conclude with a section raising some (three) common arguments I’ve seen for or against HY investing which I consider spurious, straw men, etc. These are the three points that you picked up and expanded upon.

Put another way, some arguments that I’ve seen are:
- HY is better for drawdown because “dividends are free”, selling capital cost money;
- HYP is no good because it claims that “capital doesn’t matter” and so is based on a false claim; and
- HY is better because capital gains are cheaper than income tax (or as many variations on that - for or against HY - as there are personal tax variations).

I was trying to suggest none of these three arguments is useful for deciding if HYP is a reasonable approach.

On reflection in should have been clearer and, perhaps, ignored or separated the tax issue since that may be perfectly valid to decide the matter at an individual investor level.

I hope that helps and I apologise if I caused you extra “work” (but not too much as I’m sure that “work” will have been useful for many readers of this thread).

SDN

[Gan020]

To go back to the very first post and the general discussion around a market correction of say 20%-30% which is very likely to happen once in your retirement if you retire sufficiently early.

The point I think is being missed is that if this happens when you are say 75-80, you suffer the capital loss, reduction in dividend stream and either sell more shares than anticipated to prop up your income or tighten your belt and spend less.

The issue is more important if you say retire at 55 and the 20-30% correction occurs in the next couple of years, because unless your pot is very large, you are going to have to sell a proportion of your shares to prop up your income and then the dividend stream is affected for the rest of your retirement.

I would therefore venture that the use of bonds in the early years of retirement can be very valuable (unless your pot is absolutely massive) as it does what is says on the tin. It provides an income stream but your capital is (mostly) protected. The return is lower than shares of course but that's the compromise, certainty of a lower return vs capital preservation. Do I want to be reasonably certain I can retire in comfort for the rest of my life or carry a (not insignificant) risk of the downside of your pot getting decimated in the early years.

I would suggest that this Board have unconscious bias on this matter, because the people who blew up their pot due to a large market correction aren't posting on here sharing their situation. They are still in employment regretting the day they ran too much risk (either knowingly or unknowingly)

[Alaric]

I was trying to suggest none of these three arguments is useful for deciding if HYP is a reasonable approach.

There's higher yield buy and hold investing and there's "HYP" investing. HYP as defined on these boards is an arbitrary set of rules within the general concept of higher yield investing and as such excludes many investments that could be suitable as a source of retirement income or even investing in Companies whose shares have done well.

[daveh]

I would suggest that this Board have unconscious bias on this matter, because the people who blew up their pot due to a large market correction aren't posting on here sharing their situation. They are still in employment regretting the day they ran too much risk (either knowingly or unknowingly)

I'm afraid you are wrong - there are a number of posters on here who were investing in a version of a HYP through the last correction who post regularly. I can name three from memory TJH, Dod and myself and I think a number of the other regulars Eg the two Ians, Arboridge, Gengulphus were all investing in HYPs to a lesser or greater extent over the last correction in 08/09 and are still posting.


I can't comment on the others but for me my dividend income dropped around 30% in 2009 and the income per unit wasn't back to 2008 levels until 2012 for the accumulation units or 2014 for the income units as shown in the table below:

Accumulation			Income	
		% change	% change
2003	£0.0513		£0.0505	
2004	£0.0531	3.69	£0.0510	0.99
2005	£0.0582	9.57	£0.0534	4.71
2006	£0.0661	13.45	£0.0573	7.34
2007	£0.0734	11.06	£0.0606	5.66
2008	£0.0837	14.07	£0.0661	9.11
2009	£0.0607	-27.45	£0.0457	-30.84
2010	£0.0653	7.54	£0.0470	2.75
2011	£0.0757	16.01	£0.0521	10.91
2012	£0.0936	23.55	£0.0612	17.51
2013	£0.1007	7.65	£0.0634	3.52
2014	£0.1084	7.59	£0.0654	3.24
2015	£0.1229	13.38	£0.0712	8.90
2016	£0.1408	14.59	£0.0804	12.88
2017	£0.1559	7.86	£0.0823	2.31
2018	£0.1690	8.40	£0.0850	3.29

I'm still working as I'm am still building my HYP and am still short of reaching retirement age. If my HYP was my only source of retirement income I would want it to be producing an income that was significantly greater than my requirements before I retired such that I would not be using the whole of the income for my retirement and would be reinvesting some of the dividends to grow the portfolio. In addition my minimum income requirements are a lot less than my ideal requirements so I could if necessary reduce my out goings for a while. I would not want to retire where my HYP was my only source of income and only just sufficient to cover my income requirement.


My actual situation is that I will have a DB pension that will be paid at 65 but that I could take at 60 for a small actuarial reduction or 55 for a much larger actuarial reduction. My aim in building up a HYP was 1) to provide extra income in retirement and 2) to act as a safety net if I lost my job and couldn't get another so I would have an income to tied me over to retirement. I'm now in the situation where my HYP would produce my minimum income requirement so I could live on it until I reach minimum pension age.

[Dod101]

Picking up on daveh's comment, I can confirm that I have been living off my dividends as my only source of income except, more recently, the State Pension, since the end of 1994. I thus lived through the tech bubble of 2000/1 and the financial crisis of 2008/9. I was certainly hit by the financial crisis in terms of income although capital values returned fairly quickly. It was the other way round with the tech bubble. However there was never any question of even considering a return to work! I do not know about others but I can comfortably reign in my spending if I have to and I take a sanguine attitude to the whole business. I like to think though that, after a substantial loss in the tech bubble with Cable & Wireless in particular, I am a conservative investor which may or may not help (until the next time that is!)

Dod

[SDN123]

I was trying to suggest none of these three arguments is useful for deciding if HYP is a reasonable approach.

There's higher yield buy and hold investing and there's "HYP" investing. HYP as defined on these boards is an arbitrary set of rules within the general concept of higher yield investing and as such excludes many investments that could be suitable as a source of retirement income or even investing in Companies whose shares have done well.

Hi Alaric,

I think you have two separate points here...

First, with my bold,

“HYP as defined on these boards is an arbitrary set of rules...”

Google tells me that arbitrary means “based on random choice or personal whim, rather than any reason or system.”

Based on this definition i totally disagree with your point.

As I believe you know well “HYP as defined on these boards” is based on a long conversation here and previously TMF. This particular conversation started with some TMF articles written by PYAD and the HYP system has meandered along, evolving slowly, ever since. The definition of HYP on the LF HYP Practical board is influenced by but certainly not a a carbon copy of PYAD’s articles. So, I don’t believe the current state of HYP, on these boards, is either random, nor based on any individuals whim. In fact it seems clearly to me to be a self-consistent and collectively created system. It might not be a great system but in my view it is definitely not arbitrary.

Second,

“...excludes many investments that could be suitable as a source of retirement income...”

Now I believe that is definitely true* and I think worth emphasising, repeatedly, to anyone thinking of using HYP as defined here.

*I have included an asterisk because I have two important caveats to that sentence.

1 - Nothing in HYP says that it must be your only investment system. I noted in my post that it’s currently only a small part of my strategy. Many posters on LF mention HYP as one of several strategies that they run - I recall mention of many “partner strategies” including IT income strategies, DB pensions, fixed interest investments, BTL portfolios etc.

2 - I believe that any investment strategy that aims to beat the market (in terms of income, TR or any other measure) must by definition be based on a subset of the total market and must have a different risk profile. (I strongly suspect that the academics would say a higher risk profile, but I don’t know that for sure).

Because of these two points I would rephrase your warning as follows (I’m not putting words in your mouth, this is how I would state it):

Any one considering HYP, or in fact any investment strategy other than passively buying the whole market, should be aware that they are adding risk to their portfolio with no guarantee of actually beating the market.

Rather boring, hardly contentious, but I my view very important to understand for anyone selecting any investment strategy other than passively (and boringly) buying the market.

I don’t read all of your posts on all boards and so I get a rather one eyed view of your perspective, but it seems to me that you have a particular problem with HYP “as defined on these boards”. Could you lay out, in similar detail, your suggested general HY investment strategy for me to understand and, if appropriate, use? If you are willing to do so then I’m sure a new thread on this board would be appropriate.

Thanks,

SDN