Living off Capital vs Living off Dividends

Impressive track record.

 

And one that I could have purchased many times over the years sometimes at a large discount but didn’t in large part because of the minuscule dividend although concentration and key person risk featured as well. I chose PMC instead. Don’t tell @dunno though as he’ll remind me of the yield trap. Yes there can be a downside to obsession with income at times.

 

Hey @truong given your dividend focus how did you end up owning MFF?

 

Just read the 2019 annual report and quite clear the manager is preparing owners for possible lower returns ahead. Top holdings are interesting but lots of well known names. Suspect lots market timing and trading has helped.

@Nodrog besides performance, what else have you liked about it over the years ?

 

That likely applies generally including any index where US dominates. Common sense suggests these sorts of returns can’t go on indefinitely.

Chris Mackay along with Hamish Douglas were the founders of Magellan. That will give you some hint for a start.

Rather than me do a poor job of it a search on posts about MFF from @The Falcon will likely be more useful:

Search Results for Query: Mff - PropertyChat

 

Hey Mr @dunno and others can you help this geriatric make sense of this issue please in relation to receiving a dividend vs creating one’s own dividend?

The assumption here is a broad based portfolio not a handful of direct stocks.

Of course in theory conceptually there should be no difference without getting into the nitty gritty. But I’ve often wondered what would happen say during a long drawn out severe bear market? Due to investor fear / despondency etc companies in general are likely to be trading well below their fair value based on earnings.

The “create one’s own dividend” retiree may be having to sell shares at depressed prices relative to earnings and potentially at a loss for an extended period to fund lifestyle.

However the traditional dividend investor will be receiving dividends based on earnings, not share price. Yes there will likely be a cut to dividends but generally much less relative to share price.

So in this situation which many retirees would be most fearful of is the “create one’s own dividend” by realising capital at a greater disadvantage?

Thanks in advance.

 

I've been secretly wondering this for a time too.

On one hand I know that the ASX is concentrated and sector diversification is poor, and I know there's home country bias.

But how much weight to give these technical problems in my mind?

The 98% of the investable universe out there that isn't Australia uses currencies that I won't be using to buy my bread and milk in retirement - I can avoid some of that issue with hedging but there's costs to do so.

It's also mostly globalised so that the failure of some of the most important nations would drag down the others heavily anyway - making some of the diversification benefits potentially illusory.

Then there's the political and social environments - for instance the USA is a country with more guns than people. It's a wonderful place but is that really less worrying long term than Australia having a property bubble? I'm not sure.

I'm not saying investing in Australia passes all the technical boxes, I know it has academic problems...but sometimes I wonder if in the joy of understanding modern portfolio theory and so on has made us overly zealous and overweighting these ideas in our minds.

But what do i know. I'm am amateur and this should not be taken as advice. But it's interesting to read someone else asking themselves the same questions.

 

Buying low fee oz LICs with embedded CG does not bother me as i see them as a vehicle to generate income/dividend.

However something like MFF i have trouble with as you are essentially purchasing for CG but the embedded CG built in means I cannot bring myself to buy it.

I know they are generally reasonably long term positions and unlikely to realise all of the gain.

Am i wrong in seeing that as a disadvantage?

 

AFI has some 140,000 shareholders and it's equally valid to wonder how many of them would even read the annual report let alone concern themselves with investing theory. We are but a small part of the number of investors.

For my part I like reading the subject matter as it is stimulating but I'd be hesitant to imply the other 139,999 holders of AFI are investing in a blind manner without regard to theory. I don't know them.

On that basis one answer is maybe or maybe not.

 

It wasn’t all that long ago where it was difficult / impossible to invest in listed Global funds outside Australia. ASX was basically all that was available so that’s mostly what I invested in.

I’m quite optimistic about Australia’s future relative to much of the rest of the World. However more important than say maximising performance etc I suppose it comes down to risk management / insurance. Like many forms of insurance the risk of something bad happening here is low but what if?

There’s countless very experienced investors out there (including many very wealthy ones) who seem relaxed about having most of their wealth in Australian shares. Does that mean it’s the optimal / wisest thing to do? Of course not. It’s a choice they’ve made and they sleep well regardless of what others say.

Despite me starting this thread and appearing to question if Global diversification is needed I personally would be uncomfortably owning less than 25 - 30% of same. But prior to reaching our retirement wealth goal and being keen on juicy dividends we heavily favoured ASX. Not sure what I’d do nowadays if we were back in that situation. I’m guessing I would still do the same despite the potential risks.

There’s a ton of information / data out there which suggests what the optimal approach is. Trouble is if it’s incompatible with an investor’s risk / psychological profile there’s a high probability of failure. That doesn’t mean we shouldn’t try to improve on behavioural weaknesses but there does seem to be a limit specific to each individual.

I still have many faults but I’ve improved a lot over the years. @truong ’s insightful post earlier is descriptive of me. I just get too uncomfortable if focused on the capital value of our portfolio.

During the latter part of the GFC I deliberately avoided looking at the value of our portfolio to avoid getting worried / depressed. The dividends however continued to roll into the bank accounts with surprisingly less reduction that one would think thanks to a LIC dominated portfolio where they attempted to smooth dividends during that period.

If retired and having the sell capital to fund living expenses during an event like the GFC that would bring me face to face with the rapidly declining value of the portfolio and no doubt fuel negative emotions / fear. Knowing my weaknesses this is something I want to avoid.

 

He he, I mostly only started having an occasional glance at the annual report after joining this forum. Some seemed to think I knew a thing or two about LICs so I thought I’d better have a bit of a look so as not to embarrass myself if asked a question.

 

Reading the latest MFF annual report, I think your reservations are well founded.

 

I'll weigh in on my worthless 2c.

The consequences of selling shares at a lower price is balanced by being fully invested in a bull market, that is why it is called a "safe withdrawal rate". If one is not confident in this, that just means they will need to take other measures to reduce sequence of return risk. This can be achieved by accumulating a large enough capital base to live off dividends (and reinvesting surplus) and reduce SORR.

However, a dividend focused investor may intend to achieve the same outcome with a lower capital base by focusing on high yielding stocks/countries only. There is nothing wrong with this, but although you will reduce SORR, you will increase other risks such as country/sector/asset class concentration, yield trap, lower total return etc.

I feel like there is some sort of middle ground where a lot of people are and that's why it could be very confusing (i.e. having a portion of funds diversified and a portion in high yielding stocks). As long as you understand the different risks I don't feel there is any need to compare the results as the future is unknowable.

 

Thanks @blob2004. So many variables. And of course there’s the blindingly obvious option of holding a cash buffer to top up capital / dividend shortfall.

In our case Aussie ETF / LICs are for the higher dividends, excess dividends are reinvested, global unhedged equities to protect against home country risk, a cash buffer to smooth income in troubled times and a fully offset home loan as a last resort emergency fund.

 

The yield is low because people are chasing the fat gains... Any idea on the payout ratio?

 

Option 2 & 3... noted for dividends because I guess in the context of "other income" I'd consider it dividend income. Drawing down capital to live hasn't really been a consideration.

Tapping into capital has never really been a consideration. Though it feels strange to write that though.

 

No idea sorry. The yield has always been low though as the Mgr’s believes strongly in reinvestment.

It’s not an LIC I follow and even if I did it’s not something I’d want to buy now. I get interested in quality LICs that have had a bad run not the opposite.

 

Thanks @Nodrog. Interesting read. Easy decision for me to stick with international etfs though. A product for/from a previous era maybe.

 

Yep, MFF is one of the few more adventurous LICs that we’ve allowed ourselves to own knowing that the bulk of the portfolio would cover our needs. We still have them, some have done well and some have been atrocious.

Fully agree with your comment about being dividend focused in times of great turmoil like the GFC. I know you don't like property but in our case we also hold fully paid IPs as SORR insurance.

 

This question requires context because the answer depends on all of, at once:
a) which country's stock market we are talking about
b) whether companies are picked directly or some diverse bundle is bought
c) whether the investor is trying to get by on the bare minimum or is talking about real wealth

Example: An Australian wage earner looking to live frugally with a small portfolio decides to chase a CG centric approach, as less tax will mean earlier retirement. They can't buy BRK or similar as they are borrowing to purchase and want deductible interest. So they hand pick companies with a tiny dividend that have been bid up to a massive PE (eg CSL). Massive diversification risk.

Example: Ok, our Aussie above agrees that is a bad idea, leave it the experts. He picks the latest WXX, Wilson stable high growth LIC to diversify. Oh no, it turn out they made long term 9.5% returns, like everybody else, but with a 2% MER. Surely we can do better?

Example: Ok, our Aussie says "stuff it" and picks a low fee index ETF or old school LIC. He is "forced" to take a grossed up dividend of 5-6%. He posts this result on the boglehead forums where they tell him that he must burn the extra 2% each year to ensure he reaches a safe 4% WR, and as a sacrifice to the great Bogle who would be enraged to learn of such a backwater country as ours.

Example: a super wealthy retired US boglehead owns enough sp500 proxy that the 1-2% dividends amply fund their lifestyle. He sweats about being so far below the SWR and contemplates buying a new sports car every month or so.

Example: the fellow from above instead owns exclusively BRK and funds his lifestyle in fat 300k chunks. Buffet and Munger die and it is revealed the entire company funds have been dedicated to finding a cure for their advanced age (turns out they are over 300 years old - incidentally, it turns out Buffets first and only investment as an individual was to put $10 into the NYSE the day it opened, it is now worth $100b). Hence they never could pay a dividend. Whoops! Share price drops to zero.

What is my point?

Well... Picking growth is hard, and requires trust.

Also, invest over a lifetime so that the portfolio is big enough that you are not aiming to scrape it in at 4%.