My investment approach of seeking income and growth is sometimes seen as being a poor alternative to seeking total return. I was reminded again of this by a comment (#13) on last weekend’s post on Monevator. I was inspired to pen a response.
The original commenter said that “never selling, and being ok with it, is the only way, I think, I can truly be FI [Financially Independent] and contemplate RE [Retire Early]. This obviously means I am not using my resources optimally.” They added that “my strategy is to build my investments in the form of income bearing investment trusts, in all sectors and geographies” and “currently this portfolio has a natural yield around 3%. I will be FI when I have £50k in passive income. This gives me a target of £1.67M.”
My comment (#36) in response was to say that “I think your approach can work for you. A 3% yield is actually a compromise between an all-out growth approach that would yield between 0% and 2% and my own income growth approach that is currently yielding 4.8%. I have followed this approach for fifteen years and have averaged a 4.3% yield and 4.3% capital growth each year. The total of 8.6% beats the UK market but not the World market.”
I would like to expand on that, based on my own experience and my own views. Having invested for twenty years with a combination of different approaches I decided to make changes in 2006. I had previously invested in unit trusts and investment trusts invested in UK income, UK and international growth, UK and international indexes, and technology, as well as individual UK shares. I decided to switch to a mix of UK and global equity income investment trusts. Consequently, my portfolio income yield increased from 2.59% in 2005 to 3.47% in 2006. That 34% increase became a 65% increase in actual portfolio income because of capital growth and additional savings invested during the year. Portfolio income received in 2006 represented 46% of my spending that year. That was an encouraging sign that living on portfolio income was within reach.
| Annual | Cap% | Inc% | Getting Minted | FTSE AS TR | MSCI World |
|---|---|---|---|---|---|
| 31-Dec-06 | 22.29 | 3.47 | 25.76 | 16.75 | 20.65 |
| 31-Dec-07 | -5.19 | 3.38 | -1.81 | 5.32 | 9.57 |
| 31-Dec-08 | -26.65 | 3.66 | -23.00 | -29.93 | -40.33 |
| 31-Dec-09 | 20.79 | 6.37 | 27.16 | 30.12 | 30.79 |
| 31-Dec-10 | 11.59 | 4.90 | 16.49 | 14.51 | 12.34 |
| 31-Dec-11 | 3.27 | 4.18 | 7.46 | -3.46 | -5.02 |
| 31-Dec-12 | 7.89 | 4.23 | 12.13 | 12.30 | 16.54 |
| 31-Dec-13 | 19.69 | 4.28 | 23.96 | 20.81 | 27.37 |
| 31-Dec-14 | -0.44 | 3.58 | 3.14 | 1.18 | 5.50 |
| 31-Dec-15 | -4.70 | 3.87 | -0.83 | 0.98 | -0.32 |
| 31-Dec-16 | 11.43 | 4.17 | 15.60 | 16.75 | 8.15 |
| 31-Dec-17 | 9.25 | 4.42 | 13.66 | 13.10 | 23.07 |
| 31-Dec-18 | -10.69 | 4.24 | -6.45 | -9.50 | -8.20 |
| 31-Dec-19 | 15.06 | 5.18 | 20.24 | 19.17 | 28.40 |
| 31-Dec-20 | -9.46 | 5.02 | -4.44 | -9.82 | 16.50 |
| Average | 4.28 | 4.33 | 8.60 | 6.55 | 9.67 |
| Std Dev | 13.77 | 0.79 | 14.10 | 15.31 | 18.26 |
[Total Return for Getting Minted = Cap% + Inc%]
Reviewing the data fifteen years later it is interesting that half of my returns were from income and half from capital growth. The total return beat the FTSE All Share Total Return Index performance in ten of the fifteen years. The total return has lagged that of the MSCI World Index in nine of the fifteen years. My cumulative return from that 2005 starting point remained ahead of the UK index at every year end, and only fell behind the World Index last year. Other starting points are less favourable!
| Cumulative | Getting Minted | FTSE AS TR | MSCI World |
|---|---|---|---|
| 31-Dec-05 | 100.00 | 100.00 | 100.00 |
| 31-Dec-06 | 125.76 | 116.75 | 120.65 |
| 31-Dec-07 | 123.48 | 122.96 | 132.20 |
| 31-Dec-08 | 95.08 | 86.16 | 78.88 |
| 31-Dec-09 | 120.90 | 112.11 | 103.17 |
| 31-Dec-10 | 140.84 | 128.38 | 115.90 |
| 31-Dec-11 | 151.35 | 123.94 | 110.08 |
| 31-Dec-12 | 169.70 | 139.18 | 128.29 |
| 31-Dec-13 | 210.37 | 168.14 | 163.40 |
| 31-Dec-14 | 216.97 | 170.13 | 172.39 |
| 31-Dec-15 | 215.16 | 171.79 | 171.84 |
| 31-Dec-16 | 248.74 | 200.57 | 185.84 |
| 31-Dec-17 | 282.72 | 226.84 | 228.72 |
| 31-Dec-18 | 264.50 | 205.29 | 209.96 |
| 31-Dec-19 | 318.02 | 244.65 | 269.59 |
| 31-Dec-20 | 303.90 | 220.62 | 314.07 |
| Compound Average | 7.69 | 5.42 | 7.93 |
I think shifting to a lower yield requirement than 4.8% will generate better total returns so that is what I am doing now, albeit in a very slow manner. If I switched out of my high yielding property REIT’s and bond investment trusts then my total yield would fall to 4.4%. If my UK, global and Asia Pacific equity income investment trusts better reflected the sector averages then the yield would fall further to 3.9%. I therefore think that a 4% yield target, also in line with the 4% “safe withdrawal rate” estimate, could be reasonable. A portfolio target of £1,250,000 might therefore be sufficient to achieve a £50,000 income target. This assumes that no tax is payable, i.e., the portfolio is in an ISA or covered by income tax allowances.
Making optimal use of your resources is a challenge. My tilt towards income and towards the UK has generated lower total returns for me in the last four years than would have been the case if I had just tracked the World Index. We do not know what will happen in the next four or more years so it may be that my allocations will perform more successfully, or not. Certainly seeking dividend income can limit your investment choices.
Maintaining my allocations to property and bonds (yielding over 6%) may hinder growth but it does enable me to allocate more towards growth holdings (yielding less than 3%) in the future whilst maintaining my overall income (yielding over 4%). Allocating some resources to income and some to growth may be optimal for some portfolios, depending on your overall objectives. If you can get 4.8% yield on half your portfolio, aiming for income, then you could invest the other half in a global tracker yielding 1.3% (Comment #31, Monevator), aiming for growth, and achieve an overall yield of 3.05%. Alternatively, it could be optimal to invest for growth whilst accumulating (before FI), when there is no requirement to sell to cover expenditure, and to invest for income whilst decumulating (post FI).
One advantage that I see in my approach is that my income return has been very steady around an average of 4.33%, with a standard deviation of 0.79%. Eleven of the fifteen years have an income return within the range of 3.54% and 5.11%. All fifteen were within the range of 3.38% and 6.37%. This is perhaps better illustrated in the graph above. This gives me some confidence that about half of my return is consistent year on year.
The other half of my returns is very inconsistent year on year. Capital returns were more volatile with an average of 4.28%, a standard deviation of 13.77%, and a high of 22.29% and a low of -26.65%.
With a total return strategy, the returns are similarly volatile with highs of around +30% and lows of around -30% and -40%. I’m not sure I’d want to sell 4% of my investments to cover my spending after the market had fallen by 30% or 40%. With a steady income of around 4% I feel better able to withdraw that and spend it, and to be more detached and hands-off about the volatile movements of my capital. My view may be a minority view and the opinions of others may vary somewhat!
Very interesting analysis.
A few thoughts / Q’s follow:
Was the 50/50 split growth/income by design or, for want of a better word, luck?
Relative stability/consistency to date of your income is very notable – but, of course, it is not guaranteed to continue. Time will tell – what is your view?
Volatility of total returns is one reason I am no fan of so-called safe withdrawal rate (SWR) approach and tend to a Floor & Upside approach for de-accumulation. Viewing yield-based portfolios as flooring is unusual – but I suspect may be more widespread if you could somehow guarantee your levels of income stability/consistency.
Thanks for both comments. The 50/50 was partly by design, in not reaching for too much yield, but mostly luck. I was confident of 3.5% dividends in 2006 but unsure about the capital returns. I’m still confident in 2021 about income being stable or rising but my investment trust holdings are spending their revenue reserves at present. There’s no guarantee on the income and those reserves may run out before company dividends are properly restored. Some trusts in the sectors have cut dividends and given up “dividend hero” status and others may follow, or they may pay dividends from capital. Currently I am only spending about 60% of my dividend income so that is my margin of safety.
P.S. I have just read your post of 25/6 – do the figures in this post (1/7) include or exclude your inheritance?
My total return is calculated to exclude contributions (e.g. saved or inherited) and withdrawals (e.g. drawdown spending). The calculation I use is:
Total Return = (ending balance – ½ contributions + ½ withdrawals) divided by (beginning balance + ½ contribution – ½ withdrawals) minus 1
This paper from 2004 may be of some interest you:
https://www.northwoodfamilyoffice.com/wp-content/uploads/2015/03/James_Garland_Fecundity_of_Endowments.pdf
Thanks for that link. That eight-page paper stressed the importance of having the long-term ability to generate cash to spend (fecundity) that maintains its value in real terms. After a quick review I can confirm that my portfolio returns indicate that portfolio income has increased in real terms over the period under review. Portfolio capital has also increased in real terms, albeit to a lesser extent. These are useful checks to make.
Yes I found it some time back and although on the face of it it is primarily aimed at long duration portfolios (e.g. trusts & endowments) IMO it may also have some applicability to early retirees too.
Another interesting facet the paper highlights (over the period examined) is the decrease in [US S&P] yield – ie how much the size of Pot required to generate some level of fixed real income has increased. As you note above, “dividend hero” IT’s appear to have ‘avoided’ this issue over the last 15 or so years but this may be of some concern going forwards.
The growth in the US market has greatly reduced the yields available. The UK market hasn’t had so much growth, but company dividend cuts may yet threaten the dividends being paid out by the “dividend hero” trusts that I follow.
Hey,
I am the original poster on monevator. Glad to have inspired you to pen this article.
In many ways your response seems to corroborate my suspicion that aiming for a higher yield (3-5%) is sub-optimal strategy, when compared to buying world index.
But what terrifies me is the sequence return risk. As in market falling in the 1st 1-3 yrs after retirement, thus making my withdrawals (even at 4%) in early yrs catastrophic.
Your analysis of income from a 4%+ yielding portfolio over 15+ yes is very heartening. It shows that even during the darkest days of 08 or other crises, you received nearly 4% income!
During the midst of crisis, it is not only easy/less taxing to take income as it comes, but also very reassuring. Stops you from doing stupid things that could be classified as self harm! My reasons for higher yielding portfolio are more behavioral than financial.
Thanks for your post!
Regards,
Rishi
Thanks for your comment and your original question. I’m pleased you found my experience and my views in this blogpost helpful. You might be interested in my earlier writings such as this post:
https://gettingminted.com/an-alternative-approach-to-decumulation/
Interesting article. I think in de-accumulation I could be tempted with an approach that had greater focus on regular income that naturally leads one towards investment trusts over index funds as you have done. My main concern with this approach is the increased costs that reduces your SWR and the active approach taken by trusts often to try and preserve the dividend. It’s not a problem as yet I need to confront. But I would not reach for yield which is a killer. I’m not strongly anti your approach I just think the data indicates it’s likely a sub-optimal strategy theoretically but if it works for you then that’s fine. Rishi one thing it doesn’t do is eliminate SoR risk at all. The ERN blog articulates this better than I but in essence dividends are just a component of total return. I am not sure either that 15 years of data is particularly comforting. 50 to 100 years of data would be more useful and I don’t mean that flippantly either – obviously it doesn’t exist. 08 wasn’t a bad crisis comparatively as the time length of the bear market was short. Search back to 1965 – 1981 – equities did nothing for 16 years whilst inflation raged. Ditto – 1930’s – mid 1940’s 15 years – no equities growth. That’s not to say 15 years is useless – but if you think there’s a 10% chance of you hitting 100 and you are 40 years old that’s just 25% of your potential timeframe. And history no guide to the future necessarily either. The obvious reposte is what’s the answer then – dunno but useful to understand the magnitude of the conundrum…..
Thanks for your comment. I’m reaching for more growth now! My earlier post, as mentioned above, covered the challenges of 1970 to 1982 and how my type of holding performed. It didn’t persuade me to change my approach, but it did warn of an effective dividend pay cut of close to 20% in such circumstances.