Portfolio construction - why not go all income?

Hi guys. I'm very new to shares, never owned any outside of super.

After reading up on various ideas, I have two questions. Why not invest purely for income?

As far as I understand, I can invest in a high yield fund (such as Vanguard, which is paying around 8%), and then re-invest all income.

Wouldn't this then serve as 'growth' and also avoid any additional income tax?

Then, when it comes for me to retire, I simply take what I need as income (i.e opt out of the reinvesting).

Additional question - are income returns from ETFs 'more stable/predictable' than growth? (i.e are dividends are more predictable than share prices)?

 

Well, for a start, dividend income is always taxable whether you take it as a cash payment or reinvest the dividend.
Marg

 

This is a question I also am pondering. Charts like this one make a convincing argument.


Based on capital gain, the ASX is still below its level in 2007. The only growth has come from dividends.

However, I don't think the 8% from Vanguard (presumably VHY) is sustainable whilst preserving your capital. Plus the fund has capital gains from turnover.

You might be better with a slightly lower yield from VAS or a LIC such as Milton, or blend of them and VHY.

Which is what I am currently thinking.

I'm sure experts on either side will chime in.

 

What most of us really want is not just a decent income stream, but a growing level of investment income.

Super high yields like 8% will very likely come with zero growth or perhaps prove unsustainable.

Somewhere in the middle I think is the sweet spot... 3-5% yield with a likely growth rate of 2-5%. This will see the income continue to grow with or ahead of inflation on average and is ideal for living on one day.

To answer your other question, generally yes I think it’s fair to say that dividends are more reliable than share prices in that they fluctuate much less.

And as Marg said the dividends are taxable even if reinvested. If the dividends are fully franked you’ll receive a tax credit of 30% so you’ll have to pay the difference between that and your personal tax rate.

 

That chart is a selected 11 year period chosen to tell a story. If you allow me to pick start and end dates I can create any story you want

It is true that income is typically less volatile than capital. It is also the case that investing for both ; market return, carries lower risk than either a focus on income or growth. As you have picked up, something like VHY very heavily weights to short term forecast yield. This creates high turnover within the fund due to yield chasing rebalancing, higher stock and sector concentration and weights returns to income only. The higher turnover will result in “income” being made up of capital return and dividend with lower franking. There is also the issue of forecast yield - often it is caused by price compression.

Very hard to beat STW for quality of its distributions.

 

This was my belief (although not necessarily “super” high yields) for a long time being a fan of Thornhill. Hence my dislike for high distribution assets such as listed property / infrastructure. In theory due to the high distributions there should be little in the way of growth. However these assets have exhibited excellent growth at times especially if distributions are reinvested (even in part) in a “low / no” tax environment.

As a diversifier, from a correlation perspective listed property / infrastructure can be useful. Here is the latest performance update from Sixpark:

Note also that if Labor succeed in removing franking credits, even outside of low tax environments such as Super these assets could be be beneficial to FIRE types for example. Listed property / infrastructure have higher income distributions but very little in the way of franking credits. Hence for those retired using FIRE who are typically on lower incomes combining these mostly unfranked assets with highly franked assets could still provide high income but with minimal tax. The franking credits that would be wasted by holding franked assets only will cover potentially all / most of the tax on listed property / infrastructure and even interest from cash / fixed interest.

As for Thornhill’s chart below showing the performance of Industrial Shares Vs Listed Property I’ve never been able to make sense of it. Perhaps due to start dates or whatever.

Here’s Thornhill’s chart. Not a total return chart as the income / capital are split. But it suggests that listed property performance is pathetic compared to Industrial shares:



Now here’s a total return chart using accurate data for around 27 years which is the limit available on the charting package I use. Note that listed property (AReits) total return leading up to the GFC was similar to Industrial shares. AReits then copped a hiding during the GFC but post GFC have achieved excellent growth progressively catching up to where it’s not anywhere near below that of Industrials relative to what Thornhill’s chart suggests:



That said I always get nervous posting charts / data nowadays as our resident data expert @dunno is likely to find errors in my logic.

I anxiously await @dunno’s response.

PS: Note I need to highlight my above examples relate to cap weighted, low turnover Listed prop / infra index ETFs which offer “naturally” high income yield as opposed to rule based (smart beta), high turnover ETFs such as VHY whose distributions are composed more of capital gains.

 

@Nodrog need to differentiate between yield based assets - prop and infra vs. products that chase yield ("smart beta") in equity markets. Very different things to me. As you know I support the former in a portfolio but not the latter

 

Yep I thought of that but forgot to mention it. So thanks for highlighting it. A very important point. Cap weighted low turnover Listed prop / infra index ETFs used in my examples offer “naturally” high income yield as opposed to rule based high turnover distributions (eg VHY) composed more of capital gains. Edited my previous post to reflect this.

I was responding to @Snowball ’s comment from a general perspective in that not ALL high yield assets are necessarily poor growth. @Snowball is of course correct in the context of the example of VHY provided by the OP.

 

These no mining and no reits preached by PT seriously does my head in sometimes.

I agree he uses some great dates for his charts ie, the chart from when mining had the biggest boom in history and until that point returns dwarfed industrials. I assume from that moment it would show an underperformance relative to industrials due to the good ol reversion to the mean trick. And PT doesnt like mining due to speculative nature and no divs.

Then REITs the argument goes the other way in that reits are crap due to being forced to pay out at least 90% (dont quote me on that) of their income so they cant grow the assets. Couldnt you just reinvest it yourself into more shares??

Just a few dumbass thoughts going through my mind today at work thats all!

 

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@Nodrog

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You shouldn’t have alerted me to this thread

You don't need to worry about your charts I wont get there, because I went to the top of the thread and couldn’t even get past the first chart without losing my ****.

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Charts like that are STUPID; STUPID; STUPID! Either designed by stupid people or designed to deceive.

It is not even presenting two similar measures.

Why compare “change in” capital to “return on” capital?

Here is the same data shown in a comparable way. Percentage change in capital amount & percentage change in dividend amount.

 

Phew ...

 

O’h No - I made it to your post!!!.

You have shown accumulation charts – Big tick for @Nodrog

Thornhill charts splits the dividend and income component so that he can show a picture that suits his story.

Because the industrial shares retain a higher amount, it is more akin to a partial accumulation chart. The REIT's pay out nearly everything. Its more akin to a price chart.

All you have to do to believe the superiority of industrials presented in the chart is suspend the reality that part of your REIT return could be re-invested by the investor to simulate the internal re-investment rate of the industrials to get a comparable chart. (it’s the flip side of sell some capital to produce similar income argument and its interesting to see you on the logical side when things are flipped)

Moral of the story: For comparability use accumulation charts – BECAUSE once again we all acknowledge apart from tax drag income vs growth is irrelevant, don’t we @ Nodrog.!!!!!

 

Yeah, yeah. Rub it in why don’t you.

Ok it’s a behavioural weakness, I like to see income being deposited in our accounts. Maybe it’s also a geriatric thing but it’s one of my pleasures in life receiving regular income in retirement. It’s also easy in that it doesn’t require any action / decision making by me / my wife to realise that income.

One of the joys of having enough wealth to live off the natural yield of the portfolio which importantly is broadly diversified as opposed to being dependent on a small subset of ASX equities. Also near bullet proof from a SORR perspective as it equates to a very low withdrawal rate.

Now go stand in the corner for picking on old people again

 

Boom!

I’m waiting for @dunno roving lecture series. That is something that would actually be worth paying for.

 

I still think having to drawdown capital for lifestyle has an evil influence on investors. Importantly it has to be true. Why, because it came from me. It’s a vibe thing only understood by geriatrics.

 

Rather than blindly accept Thornhill’s charts / figures regarding total return of an asset class (and his “start date”) it’s easy enough to do yourself.

I went back 25 years as that’s roughly around when AReit (LPTs) data was available in the software I’m using. This is an accumulation chart (total return = price + dividends).

Note also that the All Industrials index includes AReits which Thornhill detests.



As shown in the chart above Resources and AReits tend to be more volatile but overtime the performance is not dramatically different to the market overall. I certainly wouldn’t invest directly in a Resource Index Fund but owning something like VAS which includes market weight of Resources appears to have much less impact on ASX 300 index (VAS) performance than what Thornhill’s chart below suggests.

Then there’s product availability. The only listed Industrial index proxy is WHF. Working out the NTA discount impact over time might be difficult. But in theory WHF as an Industrial index proxy and looking at the above data suggests it might have the potential to outperform say the ASX 300 / All Ords. The biggest issue though is fees with WHF at 0.40% vs VAS at 0.14%!

Anyhow now to the most recent Thornhill’s chart I could find. He uses a different start date but compare his chart to what I’ve posted above. A very different picture:



I’m not trying to be anti Thornhill as his writing helped me a lot over the years. However I’m trying to learn to keep an open mind and not blindly discount other evidence to the contrary which I’ve been guilty of in the past at times.

The reality is no one knows at a given time in the future what equity asset class will be the outperformer including dividends. Even the large resource stocks have paid a juicy dividend at times.

I think the main thing is to try to own a broadly diversified portfolio as cheaply as possible. The volume of evidence in relation to the negative impact of fees on long term performance is huge.

Does this mean I’m now against older style LICs given their dividend focus? NO. They’re broadly diversified enough for me, LOW fee and have unique attributes that at times make them favourable to purchase.

But I have become increasingly keener on cap weighted index ETFs over time. By owning near everything in a market combined with the self cleansing nature of indexing offers a path of least regret and least maintenance. That for a retiree like me wanting an increasingly simple set and forget portfolio ain’t a bad thing at all even if those like Peter T are blind to this benefit.

Ok @dunno, what have I got wrong?