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Natural yield vs. total return
Comments
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I don't think many people seriously pursue and entirely "Natural Yield" strategy anymore, it's only seen in Victorian novels, and as pointed out if you take dividends the number of shares you own might stay the same, but the price will fall. However, Natural Yield is augmented by growth as part of a Total Return strategy which gives the flexibility to take income from different sources under varying market circumstances. Modern retirement strategies are based on modelling a Total Return strategy applied to various different asset allocations. If you emphasize bonds and dividend stocks then you are tending towards a Natural Yield strategy, but diverging from the basic assumptions about the portfolios used in the retirement income models.
And so we beat on, boats against the current, borne back ceaselessly into the past.0 -
"If you take dividends the number of shares you own might stay the same, but the price will fall."
If a company's cash flows are sustainable then, other things equal, the share price will rise into the next ex-dividend date. Paying a dividend doesn't mean a company's share price has to trend to zero.
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The slow rise would be due to the falling interest rates paid out by gilts etc during that period - higher interest investments become more desirable. There would be no causal link to inflation. By stopping the graph at 2020 you missed out the 35% fall in the INC fund 2 years later.
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I intentionally stopped the graph before rates increased and threw everything off kilter, looking instead at the years when there was no change in interest rate (just a few minor movements during the last few years). Is your point that the longer rates stayed low, the more attractive became funds which held bonds issued pre-GFC?
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A good strategy depends on clear objectives. If I remember correctly you have said that you dont need the income from your investments to meet your expenditure. If you dont need income there would seem little point in using income investments.
There are people whose objectives are different. In particular they may want a high steady income over the long term without the need for ongoing management activities and investment decisions and without losing sleep when markets fall significantly.
One option is a is an inflation-linked annuity which is very useful to cover essential expenditure but is inflexible for one-off expenditures and changes in circumstances.
Another option, the worst in my view, is to adopt a pure Total Return policy where you cover all expenditure by selling long term investments. This requires ongoing management effort and could cause great stress when markets crash. The academics have come up with strategies like Guyton Klinger but as far as I know no-one here has ever reported any experiences of using it. I can foresee problems in how you actually cut sufficient expenditure in a sufficiently short time frame.
If you are going to use a Total Return approach then in my view you really need a significant low risk buffer to withstand severe market fluctuations and accept the reduction in investable wealth and the timing issues.
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Clearly most corporate bonds redeem at par, so a capital gain is achieved by buying below par and running to maturity, or at par and experiencing a temporary increase that later evaporates if held to maturity. The fund you've selected is not actively trading its bond holdings, so the "capital gain" you are seeing arises from interest rate expectations collapsing after the bonds were bought. It is the same reason gilts had equity-like returns over the post-gfc decade. So I do not think it would always be expected. In fact the opposite would be expected when interest rate expectations rise after the fund has acquired the bonds - and that's precisely what we saw after 2020.
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You are correct that I don't need my investments for retirement income at the moment, but if I sell my rental property there might come a time when I do and then I will take some dividends from my largely stock portfolio, so an entirely Natural Yield strategy. For me a Total Return strategy is an extension of an income/natural yield strategy that adds a long term growth component to, hopefully, help to keep up with inflation. The models can be run for 100% growth equity portfolios and they often predict very large ending values or sustainable withdrawal rates, but they also have unacceptable failure rates, entirely fixed income often means lower sustainable withdrawals and/or lower predicted success rates. So a combination of fixed income and growth is probably best for most people managed for Total Return.
And so we beat on, boats against the current, borne back ceaselessly into the past.0 -
I agree you need both yield and capital gain. Where we may disagree is the use to which you should put them. I see a Total Return strategy as implying that one should put both the capital gains and yield into one big income stream whereas I would advocate using each separately and differently for the purposes they are best suited ie yield for ongoing income in the short/medium term and capital gains for long term inflation matching or more general growth.
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Between 2010 aand 2020 average gilt yields fell from 3.3% to 0.35% - you can download the data from https://www.dmo.gov.uk/data/gilt-market/historical-prices-and-yields/
Interest if 3.3% for a safe investrment may well be considered reasonable. However an interest rate of 0.35% makes it hardly worth the effort of buying gilts when more than 10 times the return could be achieved with corporate bonds. Increased demand for corporate bonds pushes the price up..
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I think our difference isn't really substantial and is more about the way we think about our portfolios. You are influenced by a chronological/risk bucket organizing principle and I've never adopted that and just relied on an overall asset allocation. As I already have a large "fixed income" allocation in annuity type products I can choose whether to rely on dividends or capital gains to fill any gaps. The choice will likely be driven by tax considerations.
And so we beat on, boats against the current, borne back ceaselessly into the past.0
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