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|
[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|
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!