Returning to normal?

Source: Pixabay

Tomorrow there are changes being made to the lockdown as the UK tries to return to normal life in the wake of the coronavirus having peaked. Personally, I’m generally in favour of steps being taken by government to relax the lockdown but I also favour being cautious in the steps we as a family take. Some schools and school years are returning to their school buildings but our current expectation is that our children will remain in our home school until September, so that’s a step we don’t get to consider yet. In the meantime, our focus will continue to be on supporting home school and surviving as a family in this ongoing health crisis situation. This leaves less time to consider how best to maintain financial independence in the face of an emerging financial crisis. I like to think we have things in reasonable order financially. We have no debts, we have sufficient cash in the bank to cover our expenditure for the next few months, and we have an equity portfolio paying out regular dividends.

A quick look at our spending in the first two months of lockdown compared to the same month’s last year suggests a 10% reduction. We have spent less on things we can’t have or don’t need right now such as holidays, dining, drinks, entertainment, petrol, travel, more clothes, and more furniture. We haven’t spent any actual cash coins and notes. We have spent a little bit more on groceries and books. Fortunately, we only had one holiday booked and paid for and that has been postponed by twelve months. We can’t contemplate booking other holidays or spending on the house at this time.

During the past five months, as the portfolio fell by 41.76%, I managed to stay calm and not sell any of my equity shares. I was trying to keep my head as others lost theirs, but also, I hadn’t been clever enough to sell anything before the market fell significantly. Eventually in late April I did sell shares to the value of about 1% of my portfolio. In not selling at the lowest point I got 32.87% more cash for my shares, albeit I got 23.55% less than I would have at the end of last year.

My share sale should cover about three month’s spending. This sale was made to increase my available cash and followed the partial recovery in stock markets. At the moment I have cash to cover eleven month’s spending. That gives me some comfort. I have more time in which to choose when to raise more cash. I am currently taking the dividend payments on my non-ISA investments and these should now cover about five month’s spending each year. I would previously sell about 1% of the portfolio every three months but I can probably delay that for up to sixteen months if I choose to.

Markets have been relatively stable since mid-April. My portfolio has reduced by 23.52% in the year to date. I would need an increase of 30.76% to restore the year end position. This reduction includes only 1.24% of draw down expenditure over five months, which implies an annual withdrawal rate of around 3%.

After allowing for the receipt of some inherited funds I am actually only 11.07% down since the start of the year.

There has been quite a variation of share price movements in the year to date from my investment trust funds from a best of -7.78% to a worst of -49.32% and a simple average of -25.07%. That worst performing trust, which is in the UK equity income sector, may be sold and a replacement bought. I could choose another UK trust or switch to the international or Asia Pacific sectors. I could choose to seek a similar dividend yield which restricts my options, or I could accept a lower yield. I’m considering my options for now.

My commercial property trust has fallen by 31.80%. That may also be sold because analysts are suggesting that it will reduce it’s dividend by about 30%. That would reduce total portfolio income by about 4%. I could switch some or all of my holding into my high yield bond fund and accept about a 13% reduction rather than that 30%. Alternatively, I could switch to equities and accept a 40% reduction rather than the 30%. I’m considering my options on that too. For now, none of my holdings have declared a reduced dividend. I’m maybe too keen on dividends but may have to opt for a lower portfolio income before one is imposed on me by dividend cuts. It’s difficult to consider switching to avoid one dividend cut and maybe receive a different dividend cut from what you buy.

After switching to a more international portfolio (“going global”) last year I currently have around 40% in UK equities and about 40% in global and Asia Pacific equities, with property, bonds and cash making up less than 20%. The international holdings, the bonds and the higher quality UK holdings have performed best this year. The property, and the more value orientated UK holdings have performed less well.

 Yield %Capital %Income %
UK5.5239.4636.40
Asia Pacific6.0522.2322.47
Global4.9219.3415.89
Bonds9.397.6812.04
Property10.697.3313.07
Cash0.193.970.13
5.99100.00100.00

I can now see me moving away from a high yield income growth investment approach towards more of a total return approach although this will likely take some months and years to evolve. As mentioned, I may switch to lower yielding trusts to avoid further poor performance and possible dividend cuts. My current portfolio income exceeds my requirements. I am reluctant to see that income fall but I don’t need it to rise necessarily. As dividends are increased (hopefully) I can switch more into lower yielders. Where my re-invested income exceeds my share sale proceeds, I can use that to switch to lower yielders. Holding such lower yielding investments will hopefully enable me to benefit from better share price growth.

It is still my assumption that I will not face significant dividend cuts because of the revenue reserves held by my dividend hero investment trusts.

Short term thinking

Source: Pixabay

It is now one month after the recent stock market low point on 19 March. I am still more concerned about health matters than financial matters. Tomorrow I will again be concerned and distracted by our children’s home school. I’m still taking stock of the situation we are in and my financial thinking is concerned with surviving this, hopefully, short term crisis. This post records my current thinking.

Based on values at the close on Thursday 19 March my portfolio had fallen by 41.76% this year of which only 0.86% was draw down spending. One month on and based on values at the close on Friday 17 April my portfolio had fallen by 24.51% this year of which only 1.00% was draw down spending.

I have also now received some inherited funds following a recent bereavement. Allowing for the uplift from that I am down by 12.31% since the turn of the year.

When I was 41.76% down, I would have needed an increase of 71.70% to recover. This reflects that if there is a 50% fall then you need a 100% increase to recover. Since that low point the increase has been 29.62%. A further increase from current values of 32.46% would complete the recovery. I worry, however, that we may see more of a decrease before we see such a further increase. The flow of news and the market reactions to come are unpredictable.

At a trust level some of the volatility has been extreme with falls of up to 63% from a twelve-month high being followed by rises of up to 105% as at Friday, when looking at daily prices over the last four months. If you are reasonably confident of your investment approach it is probably best not to look too closely at such daily movements. I look most days, which is more often than I should, but I don’t feel compelled to re-act. Rightly or wrongly, I have remained mostly passive in the markets since 10 December 2019 when I last sold shares and withdrew cash just before the election. I’m still considering reducing my high yield bond and commercial property exposure by switching to equities in my ISA. I am watching to see what will happen on dividend payments.

My current liquid cash position, my cash bucket, is enough cash to cover eight months of spending at current levels or twelve months if I reduce spending. The spending reductions would include some of the things we can’t do at present such as holidays and meals out. They also include cutbacks on discretionary spending on the house and on clothes which can be postponed. Investing in the children’s Junior ISA’s, which I record as spending, could also be reduced or stopped temporarily. I think some of these reductions will happen because of the lockdown and others I will need to decide to implement. I don’t propose to reduce other discretionary spending or charitable donations.

My non-ISA held shares are now paying out all their dividends to me. If these dividends are maintained at current levels then one year’s dividends from them will cover four months spending at current levels or seven months if I reduce spending. I reckon I can therefore avoid selling any shares or taking any dividends from my ISA for over twelve months, and maybe for nineteen months.

I may, however, choose to raise more cash now at current prices so I can increase my cash bucket to cover another three or four months of spending. This would mean selling about 1% of my portfolio. Being 97.36% invested in equities, high yield bonds, and commercial property is maybe a bit aggressive in the currently volatile markets. I should maybe raise some cash now that share prices have recovered some ground.

Dividend payments are endangered in the current situation which threatens my commitment to a natural yield approach to a safe withdrawal rate. It may be that the dividend hero investment trusts, both actual and aspiring, that I am invested in will hold firm and use their revenue reserves to make up for dividends being cancelled or reduced by the companies they hold. This seems likely if the dividend downturn lasts for only one year. Studies have shown, however, that a second year of falling company dividends would be challenging even for some of the dividend heroes. Since 2013 my spending has been below the dividends I have received. It may be that in 2020 or 2021 my dividends will fall below my spending. In the short term I can cover any shortfall by spending cash from my cash bucket.

I still believe in stocks for the long run and on that basis, I will stay near enough fully invested and mostly in equity income investment trusts invested in the UK, Asia Pacific, and global sectors. I will continue to roll with the punches as thrown by the markets. As a short-term measure, I am likely to raise cash to top up my cash bucket by selling some investments from my non-ISA holdings. What happens on dividend payments may lead me to reduce or sell off the commercial property and high yield bond trusts in my ISA. This is my short-term thinking.

Taking stock – and sitting tight

Source: Pixabay

I am now asking myself whether I have been too complacent, or even smug, about my financial position. Was my portfolio as well positioned as I thought it was? I think it was the boxer Mike Tyson who said that everyone has a plan until they are punched in the mouth. I have been punched by a 40% fall in net worth this year, and most of that in the last month.

I’m mostly a buy and hold investor with portfolio turnover of less than 10% per year. I have not tried to trade out and back in through volatile markets. I have invested predominantly in equity income for nearly fifteen years, and watched my portfolio income rise steadily. I have diversified from the UK to add global and Asia Pacific investment trusts, and then to add corporate bond and commercial property investment trusts.

The two graphs tell a different story – or I hope they do! Since taking my leave of the workplace I have managed to achieve a large increase in the income produced by a mostly equities portfolio. At the same time that portfolio has shown a steady, but less rapid, rise in value punctuated by times of volatility where values fall and rise again. Now, can I believe that the income will hold up when portfolio values have taken a steep dive akin to that of a jump off a diving board?

Things have moved so fast that my ruminations and calculations on whether to re-position were overtaken by such extreme daily price movements that I have decided to sit tight for now at least. I believe in staying invested to get the income and to capture the price growth, when it happens. I had considered reducing my exposure to my two highest yielding investment trusts – one in high yield bonds, and one in commercial property – by diversifying to other trusts in those sectors, but had done nothing. Looking back at the past month that would have made at best a marginal difference.

Based on values at the close on Thursday 19 March my portfolio had fallen by 41.76% this year of which only 0.86% was draw down spending. The value of that fall exceeds all the money I saved into the portfolio over a near thirty-year career, but I am left with most of the growth on those savings, at the moment. An alternative view is that I still have all my savings but have lost 61% of my gains. That’s about all the gains (net of draw-down) since 2011. It’s too much to comprehend. I’m determined not to sell – and thereby not to realise this paper loss!

This has compelled me to take stock of my liquid cash position and my expected expenditure. I raised cash levels ahead of the election which has helped to ensure that I have about seven months spending in available cash. If needed I can reduce spending to make this cash last for ten months. I had been re-investing all my dividends and selling down shares not in my ISA every three months to fund my expenditure. I have now set these non-ISA held shares to pay out their dividends, which will give me enough cash over the next year to cover three months spending. I reckon I can therefore avoid selling any shares or taking any dividends from my ISA for over twelve months.

One concern is what will happen to dividends in the next few months. I think the 61% of my portfolio I have in equity income investment trusts that are actual or aspiring dividend heroes will maintain and very slightly increase their dividends overall. They have dividend reserves they can use in order to sustain their dividends when the dividends they receive are reduced. If the current crisis is prolonged and dividend reserves are depleted then that may change after one or two years. I am more concerned about the 15% of my portfolio that I have in corporate bond and commercial property investment trusts. These are more likely to reduce their dividends substantially. I am considering whether to recognise that and take a dividend hit on them now by switching from them to lower yielding equity trusts.

In a way I’m not too worried by this fall in net worth because I have experienced similar falls in 1987, 2001-2002, and 2008, and seen things recover. This current crisis is, however, different to those and is unprecedented in recent history. The other aspects of this crisis do, however, give me more things to worry about than my net worth, and tend to put that aspect in perspective. I am concerned for the health and the life of myself and my family, and our friends and acquaintances. I am concerned about doing the right things in terms of social distancing, shopping but not hoarding, and helping people where we can. I am concerned about supporting our children’s education and well-being now that their school has mostly closed and lessons have moved online. I am concerned about the consequences for the UK economy and government. I think these concerns are going to weigh more heavily on me than my financial position in the next few weeks and months – so long as I have sufficient cash to cover our now reduced spending.

Investing for the tenth decade – the results

Source: Pixabay

From the end of 2012 until early in 2020 I acted under an enduring power of attorney (EPA) to manage my father’s property and financial affairs. In my previous post I explained the actions I took and the lessons I learned. I now want to analyse the results achieved.

My key performance indicators in this review are capital, income taken versus expenditure, and total return. My key comparisons are with an inflation index and an equity index.

Inflation (RPI)

My chosen inflation index is the retail price index. This index has the longest history, is more inclusive than others, and tends to be higher than these rivals. In seven years the RPI index has increased by 18.27%.

Equities (FTSE UK All Share)

My chosen equity index is the FTSE All Share total return index. I have chosen this one because my family live in the UK and the majority of this portfolio is invested in UK equities. After seven years the FTSE UK All Share total return index has increased by 77.48%. Funds that attempt to passively replicate and track the index return less than the index because of fees and tracking errors. A typical unit trust tracker (M&G Index Tracker Fund Sterling A Acc) had a total return of 72.17%.

Source: Pixabay

Capital

Capital has increased by 18.92%. This compares to an increase in RPI inflation of 18.27%. I would have been pleased to report to my dad that I maintained the value of his capital over these seven years despite the cost of his care. This was secured by the strong growth in 2019.

Year endCapitalGrowthRPIGrowth
2012100.00100.00
2013101.471.47102.672.67
2014106.575.03104.341.62
2015105.64-0.87105.591.20
2016105.14-0.47108.232.49
2017113.037.49112.684.12
2018102.17-9.59115.722.70
2019119.0516.51118.272.21
2020118.92-0.10118.270.00

Income taken versus expenditure

Income included a company pension, the state pension, an Attendance Allowance benefit, deposit interest, and dividend income from equity investments. Some of the dividend income was retained and re-invested so this table reflects only the income taken. Income increased as cash was invested in dividend paying equities and those dividends were increasingly paid out. Cash deposits were withdrawn in 2015 and 2016 to make up the income shortfall against expenditure. Care home costs began in August 2014 which is why expenditure trebled between 2013 and 2015. The retirement flat still incurred costs until it was sold in early 2017. Capital gains tax was paid in 2016. Costs in 2017 were mostly for the care home. 2018 and 2019 costs were wholly for the care home.

Year endIncomeExpenditureSpend %
2013100.0052.3752.37
2014102.6782.7780.62
2015121.55153.89126.61
2016161.39191.57118.70
2017165.48137.8883.32
2018163.36148.0090.60
2019173.29159.2991.92
20204.3513.44309.26
Total992.08939.2194.67
as % of 2013 income

Total return

The total return of 32.64% was well below the 77.48% from the FTSE All Share total return index and the 72.17% from the M&G Index Tracker Fund Sterling A Acc, a typical index tracker fund.

Year endTotal ReturnGrowthIndexGrowthTrackerGrowth
2012100.00100.00100.00
201399.75-0.25120.8120.81121.2621.26
2014104.344.60122.231.18120.89-0.31
2015106.001.59123.430.98122.831.61
2016109.863.64144.1016.75141.3215.05
2017120.069.29162.9813.10159.4112.80
2018110.82-7.70147.54-9.47145.15-8.95
2019132.1719.26175.8219.17171.6718.27
2020132.640.35177.480.95172.170.29

The main reason for the shortfall was the retirement flat. This was eventually sold for 47% of the price paid for it. I included the original price within the opening capital value. This asset also missed out on equity returns of 44% between 2012 and 2016. The second reason was the cash drag from being under invested in equities in 2013 and missing out on most of the 20% gains in that year. A third factor was missing out on the compounding of those missed gains in later years such as 2017 and 2019. There was a small cash drag in the later years as a cash reserve was held. One positive was that the assets held in equities outperformed the index by a small amount. This table analyses the percentage split of the total return shortfall.

  • Retirement flat -51.30
  • Cash drag 2013 -25.84
  • Compounding shortfall -28.70
  • Cash drag after 2013 -6.52
  • Equity result +12.36
  • Total Return shortfall -100.00

Alternative scenarios

Of course, if I had been ultra-cautious and not bought any equities and sold the existing ones then the current capital would be much reduced. The low interest available on bank deposits would not have covered the funding needed for the care home or compensated for the loss on the flat. In this situation the capital would be lower than it was in 2012. I suspect that this is the reality for many or most families in this position of self-funding, and they could eventually spend all the assets on funding care. If I had invested more quickly and avoided any cash drag the capital could now be over 20% higher. In an unrealistic situation of not holding the flat then capital could be 37% higher. This table compares these alternative scenarios.

  • Cash, no equities 66.77
  • Actual 2012 84.09
  • Actual 2020 100.00
  • Equities, no cash drag 122.81
  • Equities, no cash drag, no flat 137.36

as % of capital in early 2020

Conclusion

Overall, I feel positive that I did a good job of managing my father’s property and financial affairs. The value of his capital was maintained in line with RPI inflation. This would have been important to him and will now be helpful to his family. There was sufficient income produced to supplement the existing pension and benefit income so as to meet care home fees. Indeed, we could have dealt with more above inflation rises and contemplated more expensive care. The loss of value of the retirement flat was more than covered by growth in the equities held.

I’m conscious that this portfolio of up to 96% in equity income investment trusts is not likely to be recommended by any adviser as it would be viewed as far too risky. I took the view that investing in equities was the best way to secure sufficient income and give the prospect of growth in both income and capital. This worked out over the seven years up to early in this new year, although two months later markets have now taken a turn for the worse.

Investing for the tenth decade

Source: Pixabay

I’ve recently had a family bereavement. It’s been a sad time for the family and is the end of an era. It also brings to a close my role as an attorney looking after the financial affairs of my late father. Since the end of 2012 until early in this new year of 2020 I have acted under an enduring power of attorney (EPA) to manage his property and financial affairs. This followed a deterioration in his health and his being assessed as no longer being able to make financial decisions as he entered his tenth decade. I would now like to look back on what I did in this role and what lessons I take from it.

Actions taken

I was fortunate in that I was one of two appointed attorneys but we were appointed jointly and severally meaning that we could act together or independently. If we had been appointed jointly then we would have needed to act together and always agree before doing anything. I think this would have also made dealing with banks and investment platforms more complicated. We decided, as attorneys, that I would take the lead on managing financial matters, and my brother would assist the situation in other ways. They lived close to my dad’s retirement flat and I lived in another part of the country.

The financial position was good in that current income exceeded current living expenses. These expenses included living in a warden assisted retirement flat with a small amount of daily carer visits. Income included a company pension, the state pension and an Attendance Allowance benefit. There were no debts and substantial cash was held on deposit following the sale of a larger home a few years earlier. Unfortunately, this cash had been allowed to languish in accounts paying very little interest. A “high interest” account that had once paid 4.00% was now paying only 0.10%. A relatively small portfolio of ex-privatisation shares was also held and paid some dividend income.

It was clear, however, that residential care was likely to be needed in the near future and the current income would not support the expected costs for that. It was my view that the cash deposits would need to be invested in income producing assets.

The first thing to be done was to get the banks to recognise the enduring power of attorney that had been registered in November 2012. This required a visit to a bank branch with the registered EPA document and the required identity documents. In 2013 I was still working full time and I wasn’t living near these bank branches. I had to make a trip in March 2013 in order to get this done and to get online access to the main bank accounts. I had to make a second trip in January 2014 in order to close the account at the second bank and move the cash there to the main bank.

The second thing I did was to open a new investment dealing account in October 2013 and a new investment ISA account in March 2014. I gradually transferred cash from the bank to the investment accounts and invested in equity income investment trusts. The bank interest had been as low as 0.10% and no higher than 1.60%. The dividend yield on the trusts I chose averaged 4.05%. By July 2014 equity investments in trusts and shares had been increased to 62% of total assets and cash reduced to 17%, with the balance being the retirement flat.

These steps meant that when residential care started, in August 2014, we were better placed to fund it mostly from income. We were fortunate in finding a care home close to other members of the family, where his particular care needs could be met and where he felt at home, and where costs were below the average in what is a lower cost area of the country. My father, frugal by nature, was unreceptive to the appeal of a nearby care home that sought to emulate a luxury hotel, and was 31% more expensive!

On entering the care home and after me completing a long form a higher level of Attendance Allowance was payable, although this only covered a tiny fraction of the additional costs.

The third thing I did in January 2015 was to sell all of the ex-privatisation shares and reinvest the proceeds in more equity income investment trusts. This increased the dividend income but also provided for a better diversified portfolio. This process involved selling certificated holdings via the share registrars. It also incurred payment of capital gains tax and the preparation of a tax return.

The fourth thing I did was to sell the retirement flat. This required a collective family effort to clear the flat of items dating in some cases back to the 1930’s and was quite a challenge. After also making the flat ready for sale it was put on the market in July 2016 almost two years after being vacated. but it was March 2017 before the sale was completed. The proceeds were re-invested in more equity income investment trusts. Thus, it was only in April 2017 that I was able to achieve my preferred asset allocation of 96% in equity income investment trusts, with a dividend yield of 3.86%, and 4% in cash, earning interest of only 0.31%.

I was prepared to have such a high allocation to equities because of the dividend record of my selected trusts. I expected that the share prices would suffer volatility but that the dividend payments would continue to be increased or at least not reduced. Many of the trusts are recognised as dividend heroes by the AIC, or else they aspire to that status. That means they have increased their dividend every year for many years. Investing in such equity income investment trusts was, I thought, the best way to achieve and maintain a high level of income. This would also allow the portfolio to grow as and when stock markets rose.

The dividend income from these investments ensured that there was sufficient funding with which to top up the pension and benefit income in order to pay the care home fees for over five and a half years. By investing in investment trusts that aimed for income growth, and by tilting towards higher yielding but still mainstream trusts, I was able to grow that income by 22.90% (8.03% per annum) between April 2017 and December 2019.

Lessons

It would have been better to have had the power of attorney in place earlier, and it would have been better if I had been able to move more quickly to invest in shares. The cash had been placed on deposit before 2008 when 4% interest could be earned but as the ability to make financial decisions declined it was not managed thereafter until the EPA was in place and recognised by the bank. Being insufficiently invested in the stock market in 2013 meant that most of the gains in that year were missed.

The retirement flat was a very poor investment. It provided a convenient home for over six years from 2008, but was eventually sold in 2017 for 47% less than was paid for it. Such a retirement flat with an on-site warden was a necessity but, with hindsight, it would have been better to have tried to find an opportunity to rent rather than buy.

By contrast the ex-privatisation shares were a better investment and they made a gain of 28% between December 2012 and their sale in January 2015, and had already enjoyed higher gains since their original purchase in the 1980’s and 1990’s such that CGT was payable. Selling them in 2015 meant that I was not concerned by re-nationalisation proposals at recent general elections.

We were fortunate in our choice of care home. Starting with lower costs meant that we were better placed to deal with rises in those costs. Over nearly five years the care home fees increased by 30.18% in total with annual rises of 4.08%, 2.61%, 5.00%, 7.50% and 8.00%. This compares to the retail price index (RPI) increasing by 12.12%, and the minimum wage increasing by 30.11%. The state pension, the Attendance Allowance benefit, and the company pension (net of tax) increased by only 13.46%, 7.81% and 5.43%. This income covered 77% of the care home costs in 2015, but only 65% in 2019, because of these different rates of increase.

Actively managing the available assets by investing in income producing equities has meant that some of the available income can rise, ideally to meet rising costs, whilst the assets could also grow when markets were favourable.

Results

At the end of 2019 the available income was more than sufficient to meet the current costs and to allow for above RPI increases in the care home costs. If a higher level of care, in a more expensive care setting, had been needed that could have been a challenge. As it was events took a different turn.

I will consider more fully in a follow up post how well I did in managing these property and financial affairs over these seven years.