long term investment portfolio

[OldRider]

I had some other trivia as well that I had meant to add to previous post,
but left off, we also have a sheet that calculates dividend return on cost
best performer is DTL @ 24.76%, there are now several over 15%
AGK for example @18.04% Dividend growth is something we take notice of.

[Snoopy]

One point I've found is that extra caution is needed to keep a fairly generous cash portion for an investor who is reliant on income from a portfolio. For an investor with a $500k portfolio and 20% of it in cash, spending $30k per year can really hinder the effectiveness of a re-balancing strategy. Not sure there are any really good mechanical strategies to get around this, but having insufficient cash to reinvest near the bottom can destroy the hard work of many years. For example, if the $400k was in shares and the market crashed 40% in a year, then (assuming a steady downtrend), the client would end the year with about $62k in cash and $248k in shares, but would have only transferred about $8k across into shares through re-balancing, with just $2k going in at the bottom i.e there is not much ability for re-balancing to recover funds for them, other than to throw caution to the winds and plough the remaining cash into shares at the bottom. Anyone in this position would either need to be prepared to hold a lot more cash or put the time and effort in to a much more active strategy rather than a mechanical re-balancing system.

There are a few underlying assumptions in Lizard's post here that I think are worth questioning.

Looked at 'in total', spending $30,000 from a total investment portfolio of $500,000 is spending your portfolio proceeds at a rate of 6% per year. That requires a 'gross' income yield of somewhere just north of 8%. Not unreasonable. But over the business cycle getting a portfolio to achieve that without undue capital risk would be a challenge.

'Cash' is agnostic about where it comes from. Interest from a term deposit, or a sudden 'cash' windfall from an unexpected company takeover, can both be equally adept at paying the grocery bill or one of life's little treats. So IMO what our $500,000 nest egg owner needs to focus on is certainty of cashflow.

The last couple of business cycles in New Zealand have seen term deposit interest rates cycle between something like 7.5% and 3.9%. With $500,000 in capital that equates to a gross income fluctuation of between $19,500 and $37,500. I believe this kind of fluctuation would be barely acceptable. And that means people looking for 'steady income' need a far more sophisticated strategy than just 'term deposits', which is as Lizard suggests.

One option could be to go for very long dated company bonds. But these are only as sound as the underlying company that creates them. In New Zealand you can offer to get a similar gross yield if you buy the underlying company's share on the NZX directly. Or you could try long dated bank term deposits. But the problem here is the break fee should you suddenly decide you need your capital back.

IME the fluctuations from dividends throughout the business cycle are far less than the fluctuations from term deposits. That's because many directors are loathe to cut dividends through a business downturn they perceive as temporary. Having a solid dividend paying portfolio is usually less volatile from an income perspective rolling over term deposit investments. It is possible to decrease this volatility still further by:

1/ Investing in modestly geared utilities,
2/ Having paired concurrent investments like 'a good exporter' and 'a good importer'
3/ Investing in companies that are geograhically spread.
4/ Investing in companies that have a well run yet diversified product or service mix.

Such a portfolio will tend to not mimic the business cycle, an advantage to the fixed capital investor.

Finally the need for a steady income can be to some extent mitigated by investing in a company that allows you to 'living expense hedge'. For example owning power company shares may take some of the worry out of potential high power bills in day to day living.

With a portfolio of shares structered as above , I have found that there is no 'cash pinch' at the bottom of the business cycle, of the kind Lizard hints is inevitable.

SNOOPY

[Lizard]

With a portfolio of shares structured as above , I have found that there is no 'cash pinch' at the bottom of the business cycle, of the kind Lizard hints is inevitable.

SNOOPY

Below is a small summary of dividends (cps) paid on what seem to be Snoopy's favourite shares at FY2007 (before crisis) and FY2009 (post-crisis).



i.e. If Snoopy had been able to get $30k in cash income off a $500k portfolio before the crisis, he would have been getting $15k in cash income from those same shares 2 years later. To make up the difference, he would have had to sell $15k worth of shares. If his shares had fallen in line with the yield, they may by then have been worth only $250k less the $15k sold or $235k (I've ignored the fact he might also have had to top up income with share sales in 2008).

Now he has a portfolio of $235k with no cash to buy more shares for the recovery or participate in discounted and dilutionary capital raisings. He is unlikely to get $30k in income again until his share portfolio returns to $500k, but with each passing year that doesn't happen, he has to sell further shares to top up his income...

[Snoopy]

Below is a small summary of dividends (cps) paid on what seem to be Snoopy's favourite shares at FY2007 (before crisis) and FY2009 (post-crisis).

Lizard the attempt to bring facts into this debate is out step with general internet message board protocol. Wild accusations and gross exaggerations are de rigeur here. But since you insist on such desperate tactics I can only play your game...

I have at last had time to dig into my archives to find out if what I thought I had achieved by ditching my fixed interest portfolio and instead investing in high yielding shares has been achieved. My records are in tax years (ending 31st March) rather than calendar years. The study period I have used is the last 5 financial years as the global financial crisis has played itself out is FY2007 (ending 31st March 2007) to FY2011.

Over the years my 'income strategy' has rested on holding eight NZX shares:
Contact Energy (CEN), Lyttelton Port of Christchurch (LPC), PGG Wrightson (PGW), Restaurant Brands (RBD), Scott Technology (SCT), Sky City Entertainment (SKC), Telecom (TEL) and Turner’s Auctions (TUA). For the purpose of this exercise I shall assume all of these shares were bought on 31st March 2006.

We shall assume that on 31/03/2006 an equal amount of money was invested in each share, approximately $50,000 in each share. This gives a $400,000 share portfolio, with $100,000 still available to be invested in cash and bank term deposits for our $500,000 investor. If you round out the number of shares to be acquired to the nearest hundred, our hypothetical portfolio on acquisition looks like this:

6,400 CEN @ $7.76; 22,500 LPC @ $2.22; 27,300 PGW @ $1.83; 38,500 RBD @$1.30, 20,400 SCT @ $2.45; 9,300 SKC @ $5.36, 9,000 TEL @$5.54, 22,700 TUA @ $2.20

The dividends per share in each of the five financial years under consideration are as follows:

Financial Year: 2007, 2008, 2009, 2010, 2011
CEN: 26cps, 28cps, 28cps, 28cps, 25cps
LPC: 6.3cps, 4.2cps, 5.1cps, 4.9cps, 2.9cps
PGW: 6.0cps, 12.0cps, 16.0cps, 5.0cps, 0cps
RBD: 8.0cps, 6.0cps, 6.5cps, 8.5cps, 15.0cps
SCT: 3.0cps, 9.0cps, 0cps, 2.25cps, 4.0cps
SKC: 26.0cps, 21.0cps, 30.5cps, 6.5cps, 17.25cps
TEL: 35.5cps, 35.5cps, 23.4cps, 16.8cps, 15.4cps
TUA: 14.0cps, 13.0cps, 7.2cps, 17.0cps, 5.0cps

When calculating the portfolio cash return I have reduced the fraction of the Telecom dividend not imputed by 30% over the last few years. I have not included capital returns and the effects of cash issues on the income I have calculated, because these are not 'income'.

I calculate the total income received and the annual gross return on the original capital of this portfolio over the study period as follows:

Financial Year: 2007, 2008, 2009, 2010, 2011
$17,202.50, $18,258.00, $16, 386.90, $13,966.50, $12, 968.75
6.1%, 6.5%, 6.1%, 5.0%, 4.6%

These returns make an interesting comparison with bank term deposit rates available at the time

7.6%, 8.6%, 3.9%, 4.6%, 4.5%

The outperformance dividend payout of high yielding share portfolio, based on the original capital invested, is as follows:

-1.5%, -2.1%, +2.2%, +0.4%, +0.1%

Note that as the global financial crisis unfolds, the comparative performance of the high yielding share portfolio gets relatively better. The income is also steadier from the income shares compared to the bank fixed interest rates available. This supports my view that if shares are selected appropriately, then steadier income returns are available from high yielding shares compared to the alternative of being invested in the fixed interest market.

SNOOPY

[Lizard]

Thanks for the insights, Snoopy. Looks like you did pretty well. Interesting to see also how much the term deposit rates varied over that period, although the reality should be that staggered term deposits would smooth the returns somewhat (and provide more predictable income).

The only part of the debate your answer doesn't address is what happens when you have to realise capital to make up for reduced income. With shares, you are forced to realise that capital at what is likely to also be a low point in the share price, locking in capital losses, whereas with term deposits, the full amount should come back to you when the deposit matures. With staggered deposits and predictable future income flows, it should be possible to put aside the necessary capital from maturing investments to keep income levels stable. Taking income out of capital will hurt, no matter where it is invested, but being forced to sell shares near the lows can cause considerable long term damage which is difficult to recover from.

With a balanced porfolio, some of the fixed interest should also end up getting re-balanced into shares near the lows, which should help to recover the capital taken for income.

[Snoopy]

Thanks for the insights, Snoopy. Looks like you did pretty well. Interesting to see also how much the term deposit rates varied over that period, although the reality should be that staggered term deposits would smooth the returns somewhat (and provide more predictable income).

My own fixed interest portfolio, consisting entirely of bank term deposits, is staggered exactly as you suggest. I currently have six term deposits all invested for six monthly terms, but staggered in maturity date so that only one matures each month. These deposits have become my ‘emergency capital’, should something unexpected happen. In six months I could unwind the whole lot into cash without foregoing any interest due. So far, touch wood, I have not needed to do so. But I would certainly touch this term deposit capital first rather than having to sell shares at the bottom of the market.

Of course this strategy (investing in term deposits for relatively short periods) has worked well because of the inverse yield curve effect of shorter term interest rates (3-6 months) being higher than longer term (2-5 years) for as long as I can remember.

The only part of the debate your answer doesn't address is what happens when you have to realise capital to make up for reduced income. With shares, you are forced to realise that capital at what is likely to also be a low point in the share price, locking in capital losses, whereas with term deposits, the full amount should come back to you when the deposit matures.

It could be that an emergency arises with the market near a peak. In that instance I think there is a fair chance that I could sell one of my eight shareholdings for a good return, while maintaining portfolio diversification with the other seven.

I have carefully avoided directly answering your question Lizard, about making up income. I am not sure I accept your question as something that should be faced. Is it reasonable to expect a constant income in an environment where interest rates drop from 8.6% to 4.5%? I suppose my answer is, you will just have to spend less if you want to retain your capital!

I guess if I had to draw on capital to boost ‘income’, I would probably leave the shares part of my portfolio alone and take the extra out of my fixed interest capital. Fixed interest capital could then be restored with capital profits from a sharemarket recovery. That seems preferable to the double whammy effect of taking share capital out of the sharemarket at the bottom.

SNOOPY

[BIRMANBOY]

Nice to see someone with a well thought out plan with some flexibility built in. Good work there Snoopy.

My own fixed interest portfolio, consisting entirely of bank term deposits, is staggered exactly as you suggest. I currently have six term deposits all invested for six monthly terms, but staggered in maturity date so that only one matures each month. These deposits have become my ‘emergency capital’, should something unexpected happen. In six months I could unwind the whole lot into cash without foregoing any interest due. So far, touch wood, I have not needed to do so. But I would certainly touch this term deposit capital first rather than having to sell shares at the bottom of the market.

Of course this strategy (investing in term deposits for relatively short periods) has worked well because of the inverse yield curve effect of shorter term interest rates (3-6 months) being higher than longer term (2-5 years) for as long as I can remember.



It could be that an emergency arises with the market near a peak. In that instance I think there is a fair chance that I could sell one of my eight shareholdings for a good return, while maintaining portfolio diversification with the other seven.

I have carefully avoided directly answering your question Lizard, about making up income. I am not sure I accept your question as something that should be faced. Is it reasonable to expect a constant income in an environment where interest rates drop from 8.6% to 4.5%? I suppose my answer is, you will just have to spend less if you want to retain your capital!

I guess if I had to draw on capital to boost ‘income’, I would probably leave the shares part of my portfolio alone and take the extra out of my fixed interest capital. Fixed interest capital could then be restored with capital profits from a sharemarket recovery. That seems preferable to the double whammy effect of taking share capital out of the sharemarket at the bottom.

SNOOPY

[Lizard]

A good answer Snoopy. One interesting conundrum is the tendency of Advisors to want to manage portfolios and offer a regular income as part of the plan.Sounds great. I'd love that in retirement too - except that after 12 months, the reporting can come as a bit of a shock when it turns out the income came from capital (and the shares fell as well!).

I'm sympathetic to Advisors - it seems like something of a Catch-22 job, but I think there will be more and more looking for DIY solutions (on places like ST). And, in my own self-interest, the more DIYer's there are when it comes to lobbying for a Self-Managing-Kiwisaver option, the better it will be when it they stamp it "Compulsory".

[shasta]

A good answer Snoopy. One interesting conundrum is the tendency of Advisors to want to manage portfolios and offer a regular income as part of the plan.Sounds great. I'd love that in retirement too - except that after 12 months, the reporting can come as a bit of a shock when it turns out the income came from capital (and the shares fell as well!).

I'm sympathetic to Advisors - it seems like something of a Catch-22 job, but I think there will be more and more looking for DIY solutions (on places like ST). And, in my own self-interest, the more DIYer's there are when it comes to lobbying for a Self-Managing-Kiwisaver option, the better it will be when it they stamp it "Compulsory".

I emailed Bill English about implementing the Aussie style SMSF for Kiwisaver before the last election - got no reply

ACT however were quite keen on the idea (no surprises given there "personal responsibility" styled policies)

[voltage]

looking to find global stocks that are market leaders that have grown their dividends consistently over the last 15 years. Where can I find this information?
Also looking at blue chip global stock for a long term portfolio DIA is hard to beat with all the top names in the ETF. Advice appreciated.