Tracker fund yield - is higher better?

EdSwippet

Audaxer wrote: »

But could that not be an argument for taking natural income? A lot of retirees seem to go for a portfolio of buy and hold Investment Trusts with a history of decades of increasing dividends that yield 4% or more on their original investments.

A good question to ask at this point might be: To what extent are 'dividends' and 'natural yield' the same thing?

For a bond or gilt they clearly are. The interest or coupon is not capital. The principal amount you originally invested is. So the meaning of "living off natural income" is unambiguous. Spend the dividends, coupons or interest that the bond or gilt pays out, and leave the rest alone.

For equities, the situation is muddier. A particular stock's dividend is the result of several things, and many are not connected with the real profitability of the company. The board may want to pay a higher dividend than profits support to maintain a track record; or they may retain income for reinvestment in the business; or any number of other things. Some companies pay no dividends at all as deliberate policy, but instead reinvest everything into the business -- even though these might be great stocks to hold, an investor for whom "living off natural income" means only spending dividends would be forced to avoid them. And putting a bunch of dividend-paying stocks into an investment trust just adds another layer of dividend payment decision making uncertainty into the mix.

So it seems that for many stocks, dividends might not correlate all that well to natural yield. You can of course seek out those for which it does, but doing that artificially limits your investment opportunities.

firestone

have certainly seen it featured in Money Observer magazine & on their site and also in the Telegraph the idea for retired people with a pot of about £250,000 to pick about 10 or 11 investment trusts using the so called dividend hero's with rising div's as a basis of earning a fixed amount of hopefully £10,000
Would guess for all the talk of selling gains if indeed there is one or living on income or a bit of both there is no right or wrong its just finding the right investments to follow your plan and hopefully have the problem at the end of how to use it

Thrugelmir

EdSwippet wrote: »

For a bond or gilt they clearly are. The interest or coupon is not capital. The principal amount you originally invested is. So the meaning of "living off natural income" is unambiguous. Spend the dividends, coupons or interest that the bond or gilt pays out, and leave the rest alone.

That's fine if the stock invested in is long dated. Don't overlook the fact that many fixed income stocks are currently trading well above par. On redemption by default there'll automatically be a capital loss. Rolling over the remaining capital may well generate a lower level of income. Let alone providing any protection against inflation.

EdSwippet

Thrugelmir wrote: »

That's fine if the stock invested in is long dated. Don't overlook the fact that many fixed income stocks are currently trading well above par. On redemption by default there'll automatically be a capital loss. Rolling over the remaining capital may well generate a lower level of income. Let alone providing any protection against inflation.

Yes to all of that. I was simplifying to avoid making things murkier still.

My personal definition of 'natural yield' is the total return I get on my portfolio after subtracting inflation but including both dividends and capital gains. I feel comfortable spending that, and maybe a little more as I reach older age. I fully understand why some people would prefer to only spend dividends and never sell down any stocks. But this seems both artificial and requiring a portfolio that is skewed towards dividend paying stocks.

Eco_Miser

Audaxer wrote: »

I think that's true in theory, but I think the only way it would happen in practise would be if it was a poor performing fund and you were drawing out more each year than the value at which the fund was increasing.

That happened to me first time I retired, which put me off both fixed withdrawals and Financial Advisers.

Audaxer wrote: »

If the fund increased at 5% each year and you sold 4% of capital each year,

But the fund isn't going to increase by 5% each year, even if that's the long term average. Some years there's going to be a big drop, likely a bigger drop than the dividends from an income fund would have. So you have a greater volatility of income, or smooth out the income by selling even more shares.

Audaxer wrote: »

the value of your fund would still have increased after 30 or more years even although you would have fewer shares.

I believe that's what I said; with the problem that individual shares would become inconveniently valuable, like Berkshire Hathaway A.

Though a UK company would probably split the shares.

ColdIron

Eco_Miser wrote: »

But the fund isn't going to increase by 5% each year, even if that's the long term average. Some years there's going to be a big drop, likely a bigger drop than the dividends from an income fund would have. So you have a greater volatility of income, or smooth out the income by selling even more shares.

Indeed, gains are not linear even if the long term returns are good. One trap new retirees with a fixed capital sale strategy can fall into is where valuations fall in the early years and stay low for an extended period. This can cause a serious, perhaps irrecoverable, depletion of capital and leave you with a much taller hill to climb to recovery. You would want a Plan B for this sort of eventuality, perhaps a large cash buffer if you can afford it and maybe, you know, some income producing investments

OldMusicGuy

I am not a fan of the probability-based safe withdrawal rate approach. But then I am very risk averse and fear pound cost ravaging over the next few years as there is the possibility of a pretty big correction sooner rather than later. I have accumulated a large DC pot and savings (plus equity in the house) that I want to spend. My goal is for the pot to be depleted so that there is about 100K left in today's terms for whichever one of us makes it into their 90s.

I'm taking more of a safety-first approach. I have split my pot/savings so that about 40% will be cash or near cash (2 to 5 years bonds & ISAs), the rest is invested for a 10 to 15 year period at least in a mix of managed income funds and passive trackers. That should grow ahead of inflation so that when we reach 75 to 80 we can then decide what to do with what is left.

If there is a major correction in the short term I may move more of the cash funds into investments. But for now I have a very secure source of cash for at least the next 10 years (including equity from a house downsize) . Not very exciting and I definitely wouldn't make a good IFA, but it works for us.

Thrugelmir

Eco_Miser wrote: »

But the fund isn't going to increase by 5% each year, even if that's the long term average.

The long term average (of equities) is inclusive of the reinvestment of dividend income. Not a question of income or growth. The cake cannot be eaten twice.

Linton

Thrugelmir wrote: »

The long term average (of equities) is inclusive of the reinvestment of dividend income. Not a question of income or growth. The cake cannot be eaten twice.

True, but....

1) the dividend part of the total return will usually be much less volatile than the capital value.
2) a dividend investor will be investing preferentially in defensive companies which have a relatively safe income stream whereas someone focussed on long term growth wont. Defensive company prices would be expected to be less volatile than those of growth companies which are much more affected by sentiment.

Thrugelmir

Linton wrote: »

True, but....

1) the dividend part of the total return will usually be much less volatile than the capital value.
2) a dividend investor will be investing preferentially in defensive companies which have a relatively safe income stream whereas someone focussed on long term growth wont. Defensive company prices would be expected to be less volatile than those of growth companies which are much more affected by sentiment.

Capital values will change over a period time. As companies rise and wane. Over the years I recall investing in Polly Peck, Hanson Trust, Trafalgar House to name a few. There'll be many people that held the banks Northern Rock , RBS etc for the income. Barclays current share price is below what it was 20 years ago, likewise BT which at one point in the past was over £20.