Living off Capital vs Living off Dividends

Vanguard recently published an article that relates to this thread.
Total return investing

"The underlying question is one of portfolio construction.

How can you design a portfolio that provides income to live off while preserving your capital across your retirement?

The answer lies in recognising that the two types of return in an investment portfolio—income and capital—are interrelated. And that preferencing income over capital growth is not always the right way to go.

All investment portfolios provide two types of return. The income return is made up of the dividends and interest while the capital return comes from the growth of the value of the underlying assets over time.

The problem is many of us are hardwired to prefer an income-biased portfolio – many investors are fine with spending the total amount of income generated by a portfolio but balk at the idea of spending capital. Given a choice between a portfolio that returns 4 per cent income and 2 per cent capital growth over one that returns 2 per cent income and 4 per cent capital growth, many will prefer the one with the higher income despite the fact that both portfolios returned 6 per cent.

This preference can lead to problems when spending is not covered by the natural yield of a portfolio.

In that case, a retiree has three choices—spend less, sell assets, or overweight the portfolio to income producing assets.

That third option can lead to trouble.

Chasing income means seeking out higher yielding companies, buying fixed income investments like high-yield corporate bonds and emerging market debt or diversifying into property investments.

On the surface these provide an attractive yield, but that higher income can come at a cost as risk and return are correlated. Higher yield means higher risk.

The solution is to take a total return approach.

Total return investing involves holding a diversified portfolio that aims to maximise the overall return of the portfolio, rather than preferencing income over growth.

Total return investing has a number of advantages, led by the fact it allows investors to maintain diversification which reduces the risk of capital loss.

The approach also provides better control over the size and timing of withdrawals, allowing a retiree to decide how much and how often to take cash rather than being held to the schedule of dividend payments and distributions. Being able to reduce withdrawals in a down year dramatically increases your chances of not running out of money in retirement.

This means the portfolio's longevity3 is improved under a total return approach—and that means the portfolio can support your lifestyle for longer."

 

Thanks @dunno . Can you give an example of a 'total return approach' ? i.e a good product / s you know of or investing in yourself?

 

I’m certainly no @dunno, but VDHG and its companion funds are most likely close to what the article is promoting in one product.

Well diversified both in asset allocation, asset location and in scale. A slightly higher Oz tilt to account for our treatment of income. The ability to dial in your level of risk.

The Six Park portfolios have a similarly well-considered approach.

Or just check the asset allocation of the big industry super funds like Australian Super and QSuper.

My personal holy grail is what the Future Fund is doing. Total return as good as any, risk-adjusted return significantly better.

 

For those with time on their hands (warning, it’s long) here’s a really interesting podcast interview with Raff Arndt, CIO of the Future Fund. Great insights into how the fund operates.

Raphael Arndt – Australia’s Sovereign Wealth Fund CIO (EP.70) - Ted Seides

 

One of the coolest things about the Future Fund is that, from commencement, they have published quarterly reports on their strategy, allocation, results, mistakes and expectations.

All can be found on their site. It is a bit like Magellan or Buffet open-sourcing their deliberations.

And it is fascinating to see how things have changed over the long and short term.

Assuming their historical achievement of highish returns with considerably less risk continues (like much recent theory it has yet to be tested in something really nasty) it would seem to be the epitome of a modern portfolio.

Of course the problem for us is that we cannot duplicate the strategy, except through some of the more enlightened super funds.

I picked QSuper for my super because they seemed closest in spirit.

Personally, I would love to see the Future Fund be the default for MySuper, and open to all as a basic MySaver investment package.

It has the scale of the big Vanguard passive funds, and so far outperforms them.

 

I think you are on the right track regarding the big super funds being the next best thing to something like the Future Fund. I’d seriously consider dumping all listed exposure ex super into something like AustralIanSuper high growth if that was possible. As is I’ve got SMSF due to a large PE investment otherwise I’d have left with an industry fund. (PE is 40% of super balance...needed other funds in the SMSF for sign off)

I think it’s kinda sorta possible to replicate a similar strategic asset allocation but at higher cost and sans the tactical nous and access to first rate managers. You can get market beta very cheap, bonds cheap, size, value, momentum exposure semi cheap, global and domestic RE from cheap to expensive, private debt exposure is now doable, market neutral active strategies though are not cheap and substandard and ditto PE is problematic.

So yeah, probably won’t beat market beta but you’ll feel smarter and maybe more likely stick with it ?(guilty as charged).

 

I was actually with Aussie Super for the reasons you mention. They gave access to classes I can’t easily match, and the returns are exemplary.

But then I read a bunch of stuff about what the FF was doing to maximise risk adjusted return given the lessons of the GFC. Much less equity exposure than your basic balanced fund. Much more access to off-market allocations.

Other articles about QSuper in particular had them hewing to a similar strategy for the same reasons.

Their ‘balanced’ option has just 34% exposure to equities and a teensy 6% to Australian ones, compared to 56% and 22% for Aussie Super.

Recent Qsuper returns have lagged Aussie Super by a smallish amount. 10 year returns are similar. But on the few occasions our long super bull market has dipped (2016, 2018) QSuper has not.

Like yourself I’d dump everything into a non-super equivalent of QSuper/Aussie Super if I could.

i’m not sure why this isn’t possible.

 

Combined you could max out the $3.2 mil cap in SMSF with mostly NCC now or soon then given there’s NO limit on CC to 65 at least then direct that to Aus Sup rather than the SMSF.

What would be nice is if more large industry funds do like Hostplus in allowing SMSFs to invest in some of their funds including Infrastructure and Property which I assume includes “unlisted” assets. Maybe one day PE and other alternatives might be provided as an option. Here’s the SMSF options available at host plus:


Self Manage Invest

 

The trouble is we're limited to $100K a year in contributions, or $300K with bring forward.

 

I guess it is possible to make the case the present superannuation arrangements were intended to require retirees to consume their super balances rather than leave to their beneficiaries.

 

Yes true of course. In @The Falcon ’s case I was taking into account his and wife’s accumulation balance rolled over from Aust Super. Still a couple if they are able to take advantage of bring forward rule with SMSF could now and on July 1 contribute $800k in NCC and $100k in CC. Then there’s other strategies as mentioned recently by Paul the accountant with CC.

 

Needed to pull from Australiansuper into SMSF, a 100% PE SMSF I understand would struggle to get sign off (per my accountant, and even as is i am pushing the bounds). As is, SMSF is 43% single asset PE investment We recently did the 3 year bring forward ($300k x 2).

 

I suppose you had limited choice due to timing of PE deal but if you’d done $200k NCC this FY then on July 1 you could have done another $600k NCC under 3 yr bring forward rule.

 

A bit different from the usual allocation here and via Vanguard/Six parks etc, but in the same ballpark as QSuper:

 

Yes thats true. Though I dont think we will have much trouble getting to that $3.2m overtime with NCC's in coming years.

 

Good problem to have.

 

The way I approach this is I look for high quality business that give me some form of dividend
not the highest dividend but the dividend grow over time due to their business growing.

so over a long period of time I get both, so my dividend is very high after a long period of time but initially it maybe low then I get big capital gain to go with it, I then unlock part of this capital gain if I spot other business offering similar prospect and start the journey again.

an example of this would be SVW, I have holding at much much lower price but I ain't selling for decades
their dividend is around 2% but I expect this to grow over time and it can maintain 2% in line with
capital gain and should it drop below 2% I don't mind as long as they recycle the money in the business for much higher rate of return which they are over several years now so I am happy to ride along.

Another example is BRG I bought at $6 and still holding, it steady grow dividend over time and massive amount of capital gain .

to achieved this I usually look for business outside the top 50 or 100 and spot them early and ride them into the top 50-100 then decide what to do then

 

One thing that continues to annoy me is the 'dividends are bad' attitude that I seem to find around the net.

Even this:

They never say "preferencing capital growth is not always the right way to go" or even given a balanced pro/con, its always why dividends are inferior.

Even Passive Investing Australia's article on the matter is biased and doesnt list a single con for focusing on capital growth.
Dividends are not safer than selling stocks - Passive Investing Australia

Overall I feel that a significant amount of information out there is anti-dividend or at the very minimum biased and often present no arguments at all for why dividends could be a pro vs capital gain.

 

Product floggers are there to flog a product.

Put money in to them by all means if they suit and use them as you see fit and not their view.

Agree the slant from some can be irritating but I learned after while to mentally go.... can't say as mods wouldn't like.