Global Bond Index Fund

Linton

JohnWinder said:

what would you buy to pay your bills?

1) Fund A pays almost no dividend and no interest. Fund B pays a dividend which is currently a yield of 8%/year. Which is better as an 'income fund', or you would buy to 'pay your bills'?

And for completeness, Fund A has grown at 5%/year, give or take a bit, for the last 50 years, is widely diversified and low cost, while Fund B is a basket case of collapsing businesses like Kodak with a high management fee.

2) Be careful of overlooking the reality that investment returns are made up of capital gains and dividends (or interest). It easily leads to muddled thinking if we view something that pays a dividend as the only type of good income fund, because it completely ignores the reality that you can get income to buy your bread by realising capital gains. Yes, it's easier to passively receive a dividend than actively sell something; and yes, the taxation considerations might favour one; and yes it's not pleasant selling assets when values are down to buy bread, but all of those issues need to be 'priced', valued as to their worth/cost. The alternative, the view that income ought to be from dividends, risks leading you to poor value investment products marketed precisely to meet that possibly irrational need, which also needs to be priced. The investments you want ought to be low cost, diversified, risk/return appropriate for your needs, and transparent enough to allow assessment of their worth and suitability etc. It's total return that buys your bread, and if the total return from a government bond fund provides enough income for your needs then it's a satisfactory income fund.

1) Fund A pays no dividend/interest but has shown double digit annual returns over the past 5 years from its portfolio of well chosen companies working at the forefront of technical developments frequently recommended by respected analysts .  Fund B includes well established, large and highly profitable companies that are major players in sectors with little opportunity for growth that have paid steady dividends of around 5% for many years but whose share price has barely kept up with inflation.  It also contains a wide range of investments paying out steady interest from bonds, long term loans, property etc.

Which would you choose to produce the income essential to cover your basic day to day expenses?  How would you feel and what would you do if you woke up one morning to find that Fund A had dropped in value by 30%? You may panic and sell your investments as a stop-loss. More sensibly you could think it prudent to upset your spouse and cancel next year's major anniversary planned world cruise? Or perhaps save some money by stopping your regular visit to your favourite restaurant.   Rather likely you would be kicking yourself for not investing in fund B which continues to pay out at the same rate as previously.

2) Wide diversification is essential at the overall portfolio level.  But portfolio diversification does not imply the same set of possibly inappropriate investments should be used to meet each of your objectives.    If you want inflation cover over the long term and to minimise the chances of having future insufficient capital you need to take shorter term risks.  In my view it is foolish and unnecessary to take those risks when meeting your short/medium term needs. Horses for courses.

aroominyork

But, Linton, you would structure your portfolios differently depending whether you own A or B. With A you would have more of a cash and govt/high grade bond buffer to avoid selling shares at a loss. With B that buffer is less necessary.

JohnWinder

How would you feel and what would you do if you woke up one morning to find that Fund A had dropped in value by 30%? You may panic and sell your investments..

It's an important point. I focussed on choosing a 'better' portfolio, but we could all ignore a lot of the nuances and still have a good enough portfolio. What then becomes crucial is not goofing it up with behavioural errors like that; we have met the enemy and it is us. If one has to forfeit 10% of potential gains (with fees 0.37%/year higher over 25 years) it's worth it if it stops you messing up unwisely. Or pay an advisor 0.5%/year to stop you, if they can.

'Rather likely you would be kicking yourself for not investing in fund B which continues to pay out at the same rate as previously.'

I've suggested before that such a situation might indicate the portfolio is generous enough to suffer a crash but still send you on the cruise, in which case lots of approaches to investing would work; or that continuing to take cruises in a crash because the dividends keep coming might be putting your head in the sand with a portfolio on its way to crash and burn.

JohnWinder

'Have you considered a monthly income fund to pay those bills? A couple of good ones which have also had good capital growth over 5 years are Aegon Diversified Monthly Income'

This illustrates some of the points I offered with Funds A and B.

The Aegon fund as an alternative to VLS 40 (since Aegon is in the 20-60% equities range) seems a poor choice unless you want the higher income without selling. Firstly, it costs 0.37%/year more in management fee; over 25 years this hands 10% of your profits to the fund manager that you would otherwise have kept. Secondly, it's an actively managed fund, about which Morningstar's active/passive barometer and SPIVA's reports suggest will mean that it will underperform something comparable with near certainty over a couple of decades. The EU securities regulator's report from 2019 says the same thing: ' costs are higher for actively managed equity funds compared to passively managed equity funds, which leads to lower performance net of costs for active compared to passive funds;'

https://www.esma.europa.eu/sites/default/files/library/esma50-165-731-asr-performance_and_costs_of_retail_investments_products_in_the_eu.pdf

Thirdly, do active balanced funds like Aegon's do well? Under 5% might: https://www.pipsbenchmark.com/2023/05/does-award-winning-fund-beat-benchmark.html

Hoenir

ColdIron said:

It's not really an income fund with its relatively low yield, there are better funds for that purpose. It's better suited to controlling volatility, especially currency fluctuations with its hedging

The historic low yield is a byproduct of the era that's being left behind. Much of the return will be in the form of capital. As bonds mature and are replaced with new issuance. Then the distributable yield will slowly and progressively increase. 

MarcoM

JohnWinder said:

what would you buy to pay your bills?

Fund A pays almost no dividend and no interest. Fund B pays a dividend which is currently a yield of 8%/year. Which is better as an 'income fund', or you would buy to 'pay your bills'?

And for completeness, Fund A has grown at 5%/year, give or take a bit, for the last 50 years, is widely diversified and low cost, while Fund B is a basket case of collapsing businesses like Kodak with a high management fee.

Be careful of overlooking the reality that investment returns are made up of capital gains and dividends (or interest). It easily leads to muddled thinking if we view something that pays a dividend as the only type of good income fund, because it completely ignores the reality that you can get income to buy your bread by realising capital gains. Yes, it's easier to passively receive a dividend than actively sell something; and yes, the taxation considerations might favour one; and yes it's not pleasant selling assets when values are down to buy bread, but all of those issues need to be 'priced', valued as to their worth/cost. The alternative, the view that income ought to be from dividends, risks leading you to poor value investment products marketed precisely to meet that possibly irrational need, which also needs to be priced. The investments you want ought to be low cost, diversified, risk/return appropriate for your needs, and transparent enough to allow assessment of their worth and suitability etc. It's total return that buys your bread, and if the total return from a government bond fund provides enough income for your needs then it's a satisfactory income fund.

thank you for ther very good advice.
If one has a capital gain loss carried over from previous years I guess it make sense to generate income from selling something and then not pay tax on this compared to getting a dividend from another fund and then having to pay dividend tax?

eskbanker

MarcoM said:
If one has a capital gain loss carried over from previous years I guess it make sense to generate income from selling something and then not pay tax on this compared to getting a dividend from another fund and then having to pay dividend tax?

Capital losses can't be offset against income tax, if that's what you're suggesting?

JohnWinder

Can't help with tax, sorry.

Linton

aroominyork said:

But, Linton, you would structure your portfolios differently depending whether you own A or B. With A you would have more of a cash and govt/high grade bond buffer to avoid selling shares at a loss. With B that buffer is less necessary.

 Buffers have at least two different roles….

a) to avoid selling shares in a crash. I dislike this approach because it requires timing when to switch your income streams. You are likely to get it wrong or worry about doing so. 

b) flexibility in timing of expenditure for one-offs. With sufficient money you can book your world cruise, buy a new car, or pay a large repair bill without worrying about where the money is coming from in the short/medium term.


Putting all income into the buffer and always taking expenditure  from it makes (a) unnecessary and facilitates (b). However having too high a risk funds generating income decreases the amount of the buffer you can safely use for expenditure flexibility.  My aim is to at least cover essential on-going expenditure with safe-ish but somewhat high rate dividends & interest eg 5-6% dividends and even higher fixed interest. It’s a balance.

Linton

MarcoM said:

JohnWinder said:

what would you buy to pay your bills?

Fund A pays almost no dividend and no interest. Fund B pays a dividend which is currently a yield of 8%/year. Which is better as an 'income fund', or you would buy to 'pay your bills'?

And for completeness, Fund A has grown at 5%/year, give or take a bit, for the last 50 years, is widely diversified and low cost, while Fund B is a basket case of collapsing businesses like Kodak with a high management fee.

Be careful of overlooking the reality that investment returns are made up of capital gains and dividends (or interest). It easily leads to muddled thinking if we view something that pays a dividend as the only type of good income fund, because it completely ignores the reality that you can get income to buy your bread by realising capital gains. Yes, it's easier to passively receive a dividend than actively sell something; and yes, the taxation considerations might favour one; and yes it's not pleasant selling assets when values are down to buy bread, but all of those issues need to be 'priced', valued as to their worth/cost. The alternative, the view that income ought to be from dividends, risks leading you to poor value investment products marketed precisely to meet that possibly irrational need, which also needs to be priced. The investments you want ought to be low cost, diversified, risk/return appropriate for your needs, and transparent enough to allow assessment of their worth and suitability etc. It's total return that buys your bread, and if the total return from a government bond fund provides enough income for your needs then it's a satisfactory income fund.

thank you for ther very good advice.
If one has a capital gain loss carried over from previous years I guess it make sense to generate income from selling something and then not pay tax on this compared to getting a dividend from another fund and then having to pay dividend tax?

Even better to keep your income generating investments in an S&S ISA.  Unlike a pension it doesnt cut into your basic rate tax band.