≡ Menu

Lars Kroijer on…dividend stocks, emerging and small cap trackers, and cash

I am super happy to welcome back Lars Kroijer for another investing Q&A. This is a collaboration between Monevator and Lars’ own YouTube channel.

All the questions below come from Monevator readers. As before, Lars’ answers in both video and edited transcripts.

Note: embedded videos are not always displayed by email browsers. If you’re a Monevator email subscriber and you can’t see three videos below, please head to our website to view this Q&A with Lars Kroijer.

What’s the case against dividend stocks?

We start this time with a question from Ray. He is in the de-accumulation phase, but he’s still looking for a return on his investments.

Ray notes that Lars tends to recommend global equity market trackers. However, Ray continues, “this year, the ACWI – the All Country World Index – is only paying a 1.7% dividend, whereas my dividend-focused ETFs seem to be doing better than that. So is my strategy wrong?”

Lars replies:

So here we’re in the world of equities. I have explained elsewhere why most people should not have just equities in their portfolio. It is typically far too risky. Please see my other work for more on that.

It’s also worth noting that I argue you can’t outperform the markets. You should simply buy equities in proportion to their market value and diversify across the total world market as much as you possibly can, and as cheaply as you can. We do that is because we don’t think we can allocate value between equities in a superior way to the market. We accept that we cannot beat the market.

On to this question about dividends.

The first thing to ask: is there any reason to think that dividend paying stocks overall will outperform non-dividend paying stocks? And the answer to that is, no – unless you think you can beat the markets.

With dividend-paying stocks, you get a change in the share price – capital appreciation – plus the dividend. Whereas with non-dividend paying stocks, you just get that change in the share price.

Now I think what Ray is alluding to – and practically speaking, I can see an argument for – is automatically receiving dividends into your bank account. You need the cash, perhaps for your living expenses. If you have non-dividend paying stocks, you have to sell securities to realize your capital to get that cash. That can be a headache for some people.

I think the overriding issue is one of tax.

Suppose we have two groups of stocks. One pays a 5% annual dividend and the other does not pay a dividend.

Let us say the first group is flat for the year. But you received your 5% dividend, so your $100 became $100 plus $5 as a dividend.

With the second group you do not receive any dividend. However those shares went up by $5. So they are now worth $105.

This could be a similar group of stocks. It could even be index trackers with different payout policies, which may be what Ray is alluding to.

Anyway, with the second group, to obtain the cash you would have gotten from your dividends with the first group, you can sell 5% of your portfolio. You should – ignoring tax – be equally well-off.

For most people, in one case you would be paying a dividend tax and in the other a capital gains tax. That choice is what should drive your decision. It’s not that we think we can predict which group of stocks will do better. It’s more that your individual tax situation should drive it.

Also note some trackers pay out the dividends they receive from the underlying companies. Others reinvest it. Again, which type you own should depend on your current and expected future tax situation.

That should be the driver, not the dividend policies of the underlying businesses.

Beyond a global tracker for equities

Next up is ‘MBA’, who asks: “Does your case for using a global tracker fund mean one should not invest in a global smaller company tracker? At the moment, my split is 60% global all caps, 20% global smaller companies, and 20% emerging markets.”

Over to Lars:

Let me start by emphasizing that I believe you should really try – with the equity portion of your portfolio – to own equities in proportion to their market values.

Of course most people should not only own equities. There are other videos I’ve done on how you should think about your split between different asset classes. Equities-only would be too risky for most people.

Ideally, you should invest in equities according to their market value. You are essentially saying each dollar invested in equities is equally clever and well-informed. You don’t think you can do better by allocating the proportions of your stocks in a different way from what the market has already done.

You say this because you accept you cannot outperform the markets. You’re simply trying to capture the global equity risk premium. What this is is anyone’s guess! But historically, equities have outperformed the risk-free rate by about 4-5% above inflation.

I am saying you should invest in all equities to capture this premium.

But in reality, as MBA suggests, a lot of the indices do not really include small caps. Small caps may be too expensive or illiquid to trade. It’s therefore hard to represent them perfectly, all over the world. So very often they’re excluded – certainly in the larger indices.

Likewise, a lot of indices have a heavier weighting to the US market compared to its share of GDP, or to global equity values. There are various reasons for this. One is there is a disproportionate number of huge global companies quoted in the US. Think Google, Facebook, Apple, and so on. These are all large global firms, with a lot of business outside the US. The stocks are bought on the US market. But that does not mean you’re only exposed to the US economy with them.

In any case I don’t really have a problem as to what MBA suggests with people that say “I kind of want to correct this lack of exposure to small caps” or “I kind of want to get a little bit away from what some perceive as an overexposure to the US stock markets”. You might do that by buying small cap index funds. Just be sure you do it in a globally diversified way.

Make sure you do not end up with a portfolio where you essentially become a collector of indices. You can have so many indices tracked that you don’t quite know what is there or why.

A lot of global indices are highly-correlated. I think you get 95% of the way there by owning a global tracker.

Holding cash instead of government bonds

Our last question comes from ‘Haphazard’, who asks, “Do you still believe the lowest-risk part of a portfolio should be in a government bond fund? Even with today’s very low negative yields – as opposed to cash, for example?”

Lars replies:

First, a reminder. I believe that for a large majority of investors, you can create a very robust portfolio with two products. You select the lowest risk government bond in your currency and at the appropriate maturity, and you combine that with a global equity index tracker. You choose the proportion to suit your individual risk preferences.

Check out my previous video series on Monevator for more on that.

Coming back to Haphazard’s question, I don’t have a problem with cash. I would just encourage you to think of the risk of the bank where you have your cash, versus the risk of a local government bond.

For most developed economies, there is a deposit insurance. The government guarantees deposits and banks up to a certain amount.

That means for up to that amount you’re effectively taking government risk.

As a side note, this means if you have your money with one of the larger banks in your country, there is a high correlation between the failure of that bank and the failure of your government. I know that in a lot of the economies around the world that may seem remote in early 2021, but it is something to think about.

I would also say be careful about going yield hunting among other country’s government bonds. You would be taking FX risk in a lot of cases. Also, if you’re getting a higher yield you’ll typically be taking some credit risk. The higher yield alone does not tell the whole story.

Most people would intuitively understand the very high interest rates you’re getting from governments like that of Venezuela do not make much sense. You’re taking massive FX risk and credit risk. People would therefore stay away. But even in less extreme samples, you’re taking FX risk and credit risk if you are getting a higher yield.

Coming back to cash – and maybe cash alternatives – with your local bank. As long as it is within the insurance limits, then absolutely take it if you’re getting higher yields.

However if you’re buying your local bank’s fixed income products and they’re giving you a far higher return than your local government bond – and you aren’t within the deposit insurance – I’d encourage you to understand what kind of risk you are taking.

Are you well-equipped to take that risk?

For example, you might make higher returns with corporate bonds than your government’s bonds. But you’re also taking a different and in some cases a far higher risk that you may not be very well-equipped to take.

I also worry a bit when people say interest rates are so low they cannot possibly go any lower. Predicting interest rates is like predicting stock markets. It’s very hard for individual investors to do better than the market.

I’d encourage you to really think about what it is you believe you know that enables you to do that.

If you feel the minimal-risk asset’s interest rate does not give you enough return in your simple two-product portfolio – and you’re willing to take more risk – I’d say maybe take that risk in the equity markets. At least that keeps things simple.

The lowest risk part of your portfolio is not a return generator. It is the part where you say you’re not going to lose this money, come what may. So perhaps try not to be greedy!

Until next time

Please do follow-up Lars’ answers in the comments below. You can also ask us questions for next time, although we’ll only be able to pick three of them.

Watch more videos in this series. You can also check out Lars’ previous Monevator pieces and his book, Investing Demystified.

Receive my articles for free in your inbox. Type your email and press submit:

{ 42 comments… add one }
  • 1 Naeclue April 15, 2021, 4:15 pm

    The question on dividends raises another question I have wondered about for some time and maybe unanswerable, but here goes.

    Imagine splitting the global equity market by dividend yield precisely into 2 portfolios of equal capitalisation. You would then have the higher yield portfolio paying much more in dividends than the other, but having lower expected capital appreciation. Assuming an efficient market and both portfolios carried the same risk, they would have the same expected total return. It would be necessary to rebalance regularly otherwise the higher yield portfolio would get left behind as dividends were removed, and also to take account of high yielding companies becoming low yielders and vice versa. In practise the performance of the portfolios would vary. Sometimes high yield doing better, sometimes low yield, but in an efficient market it would not be possible to pick a winner in advance.

    But what about returns after tax? The higher yield portfolio would be subject to more tax on dividends than the lower yield portfolio, but less tax on capital gains. It seems to me that the total tax in most years would likely be higher on the high yield portfolio. Dividend withholding tax is largely unavoidable by most shareholders even though some income taxes may be avoidable for tax advantaged accounts and by some institutions, such as pension funds. OTOH, taxes on capital gains usually only apply to realised gains, which means they can be mitigated by not realising gains too frequently.

    I cannot prove it, but assume I am right in saying that the higher yield portfolio pays more tax than the lower yield portfolio. In that case, can the low yield portfolio be expected to have a higher net of tax return than the higher yield portfolio? Or does the market take account of this difference in taxation and adjust prices so that the portfolios have the same expected net of tax return?

    If the latter was true (the market adjusts for taxes) that would imply it was worthwhile overweighting higher yielding shares in jurisdictions that paid less than average tax on dividends. On the other hand if the market does not adjust for taxes, higher yielding shares would best be underweighted except in those circumstances where dividend taxes can be completely avoided, such as in some pension funds.

  • 2 AJ April 15, 2021, 6:29 pm

    > I would also say be careful about going yield hunting among other country’s government bonds. You would be taking FX risk in a lot of cases. Also, if you’re getting a higher yield you’ll typically be taking some credit risk. The higher yield alone does not tell the whole story.

    Vanguard offer a couple of ETFs: U.K. Gilt UCITS ETF (VGOV) and Global Aggregate Bond UCITS ETF (VAGP). Both lower risk than buying Venezuelan debt, I hope. The first is UK gilts; the latter heavy on US treasury bills. Both are Irish UCITS . The latter is relatively new. The gilt ETF is cheaper; Vanguard rate the global ETF as lower risk.

    Just wondering if the crowd has opinions on their merits.

  • 3 xxd09 April 16, 2021, 9:47 am

    I have used the equivalent OIEC for many years -Vanguard Global Bond Index Fund hedged to the Pound (VIGBBD)
    Shows how old I am because ETFs were not available at the time
    It is hedged to the Pound
    Has been 65% of my money pile for over 9 years
    It is there for damping of volatility in my portfolio-it has done that successfully
    Also has had a increase in NAV of over 4% pa as a bonus
    Will this be the same going forward-probably
    xxd09

  • 4 Seeking Fire April 16, 2021, 12:32 pm

    Great article in that it is brutal in its simplicity. Perhaps one the wider wealth management industry does not want you to read. Can be applicable to a 5 or 8 figure portfolio.

    Bonds can outperform equities over long periods of time – 30 years to 2011 for example and so even in today’s climate it makes sense to hold them. In the 1970’s equities did nothing overall. I add a couple of assets – Gold / $TIPS largely for insurance purposes whilst knowing this is likely sub-optimal asset allocation exercise.

    Naeclue – I think I agree with your comments although consider that applicability of the theory would likely be to quantitative funds as opposed to an individual investor. In addition, in an efficient market (per your first paragraph) one would expect that to get competed away. Perhaps we will see the composition of the UK market change if dividends are taxed more highly in the future.

  • 5 DavidV April 16, 2021, 1:10 pm

    In a Lars Kroijer-style two-product portfolio, what is the ‘appropriate maturity’ for the lowest risk government bond element of the portfolio when in decumulation? Is it as close to zero as possible on the basis that you are already potentially drawing on the investment for living expenses? Or is it your life expectancy? If the latter, is it median life expectancy or planning life expectancy, e.g. 10-percentile?

  • 6 Matthew April 16, 2021, 2:32 pm

    I would say that overweighting small caps/emerging markets isn’t necessarily saying you think it is wrongly priced but that every asset is perfectly priced for it’s level of risk and that you’re simply trying to slide up the risk scale beyond what 100% equities would normally be without using margin, although that’s a level of risk that few really need, and I personally also feel that despite the correlation you lose a lot of reliability by diverting.

    Lars says to try to keep risk out of the safe part of the portfolio, therefore I think cash in the best accounts should be considered within the asset allocation and not outside it – otherwise people might feel like they’re taking a lot of risk seeing their portfolio nosedive but forgetting the cash that they also have, and they might panic unduly. Also people forget DB pensions, state pension, inheritances that are likely to come, equity release, insurances and universal credit – a lot of those aren’t perfect but people forget the options they actually have.

  • 7 The Rhino April 16, 2021, 6:13 pm

    Thinking about tax – are folk putting their equities in ISA/SIPP and their gilts in GIAs? Is there a MV article about that?

    I’m starting to think about decumulation (reading McClung) and the sad realisation that LifeStrategy’s aren’t really going to be a suitable product anymore 🙁

    But they’ve been great for a good long while!

  • 8 Gizzard April 16, 2021, 6:45 pm

    @DavidV I think the time horizon is when you want to access the money. So, you might have some short term, medium term and long term GILTS, which you would cash in sequentially.

  • 9 BerkshirePat April 16, 2021, 7:13 pm

    I’m still not convinced that Gilts are a sensible option ‘at the moment’ …
    I’m currently avoiding and I’m using regular and ISA fixed term ‘bonds’ (under FSCS limits), NS&I index linked bonds (OK not available to buy now), Premium Bonds, and a regular investment in real ale to dull the pain

  • 10 DavidV April 16, 2021, 7:33 pm

    @The Rhino (7) I’ve always taken the view that bonds should be in tax shelters wherever possible as coupons above the £1k personal savings allowance are taxed at 20% (basic rate). Dividends above the £2k allowance from equities that cannot be sheltered are only taxed at 7.5%.

  • 11 Seeking Fire April 16, 2021, 7:41 pm

    DavidV – intuitively that makes sense but I believe that’s generally incorrect logic. S&P500 has returned on average circa 10% per year nominal (I make a a very broad statement for simplicity purposes). The probability is that therefore it will grow more than bonds (not always see my previous comment)! Therefore you should want to tax shield this growth and paying tax on your bonds are a lesser evil. I acknowledge it depends to an extent on your personal situation and portfolio size. Full disclosure my tax free accounts are 100% equities. Bonds are held in a GIA. Happy for someone to disagree with that view.

  • 12 DavidV April 16, 2021, 7:45 pm

    @Gizzard (8) Thanks for your thoughts. I guess the logical extension of this is to construct a gilt ladder and withdraw the coupons and maturing gilts. However, once you take rebalancing with the equity component of the portfolio into account, I’m not sure there would be much practical difference from using a single gilt fund containing all maturities.

  • 13 Matthew April 16, 2021, 7:46 pm

    @Rhino – Well I’d give the most sheltering to the fastest growing part – i.e. equities, and even then I’d use the ISAs more for that because of tax on growth and LTA. Ideally you’d shelter bonds too, at least in sipp, but if I had to choose what to not shelter it’d be the most cautious part

    I.e. you wouldn’t use up your ISA allowance on cash

  • 14 The Rhino April 16, 2021, 7:47 pm

    @DV, SF – This is exactly the conundrum I’m pondering. My thinking was in decumulation the CGT on selling down is *probably* going to be much worse for equities than bonds, and that in decumulation CGT may dwarf tax paid on income or dividends. I need to think about it a bit more and maybe run through a few scenarios

  • 15 DavidV April 16, 2021, 8:13 pm

    @SF (11), Matthew (13), The Rhino (14). Agreed a large amount of unsheltered equities can give rise to CGT problems. I am having to manage this myself as I had an AVC taken as tax-free cash that I invested in a global fund in a GIA. I haven’t been able to shelter this fully yet. At the end of the last tax year and beginning of this I have been shuffling between HSBC FTSE All World and Vanguard Global All Cap to make best use of my £12300 annual exempt amount. I would add that when considering drawdown income, the £12300 allowance (if it persists) is much more generous than either the interest or dividend tax-free allowances.

  • 16 Jonathan B April 16, 2021, 9:01 pm

    @Berkshire Pat, “regular investment in real ale to dull the pain”. For me at least that has only been available this last week after a 5 month gap. Though with hunting you can find one or two bottle conditioned beers.

    But on point, where I had previously been slowly changing investments towards bonds following retirement they are currently going back into shares. But a mix is still the strategy.

  • 17 BeardyBillionaireBloke April 16, 2021, 9:53 pm

    > to obtain the cash you would have gotten from your dividends with the first group, you can sell 5% of your portfolio

    To quibble with the maths, 5 out of 105 is about 4.76%.

  • 18 Iaquwe April 17, 2021, 1:01 am

    Dividends are far more predictable than gains in share price. I’d rather pay the tax and have emotional peace of mind than be at the mercy of mr market whenever I need liquidity. As a former boglehead, ignoring this huge emotional aspect of dividend investing is something that the anti-dividend, index camp (or cult) seriously underestimates.

  • 19 Seeking Fire April 17, 2021, 11:20 am

    @15 David V – Yes agree. It does depend on your portfolio size / personal position. For example if you are at or near your LTA SIPP amount it may make sense to hold bonds in the SIPP to minimise CGT (it may not as well). As it happens I have used the CGT allowance to extinguish bond CG.

    @18 Iaquwe – again intuitively correct but arithmetically speaking there should be no difference from selling units in a equity investment be it a company or an index than receiving the equivalent amount in a dividend. Although human beings like the regularity of income hence annuities continue to have a place and why dividend paying stocks are highly valued. If a company is worth £90 and has £10 in cash what is the difference between being paid that £10 in a dividend or you selling 10% of the company. Both result in a remaining investment of £90. Tax excluded – generally speaking it’s better not to pay the tax so you can roll up gains. As we have all seen in 2020 dividends can also get cut substantially. Having said all of that….who doesn’t like the feeling of dividends hitting your account (I certainly do)….feels like free money doesn’t it. It’s not – it’s a return of your capital. imho.

  • 20 xeny April 17, 2021, 11:25 am

    @Iaquwe

    You might want to look at roughly year old posts in the Lemon Fool forum, specifically the HYP section which espouses that approach (or cult). The levels of unhappiness last year when dividends were being cancelled on a broad scale, and the stocks that were losing value the most tended to be those self same non dividend paying stocks was something to behold.

    A dividend based approach seems great at generating peace of mind until all of a sudden it isn’t.

  • 21 EcoMiser April 17, 2021, 12:36 pm

    @Seeking Fire #19

    If a company is worth £90 and has £10 in cash what is the difference between being paid that £10 in a dividend or you selling 10% of the company.

    Two differences in my opinion:
    1: If you get the dividend you’ve got £10, when you sell 10% of the company you may find you are only offered £9. (Discount to NAV)
    2: if you sell 10% of the company you’ve got a lower fraction of the company and a smaller share of its future profits. Keep doing that and you find you’ve nothing left.

  • 22 BerkshirePat April 17, 2021, 12:59 pm

    @Jonathan B – yes, I’ve had to make do with ‘craft beer’ in cans from the likes of Siren and Mikkeler – I’m back to local pub tonight hopefully. Nothing tastes quite as good as proper beer in a pub!
    Despite being >4 years away from proper retirement (at 60) I’m still heavily biased towards equities- gradually shifting to VWRL away from individual shares. The fixed income in my ISA is mainly prefs, and a dollop of SLXX (
    iShares corporate bond fund)

  • 23 xxd09 April 17, 2021, 1:18 pm

    Dividends in retirement are understandably a very human attempts to replace the salary you have just lost
    Unfortunately it’s not a 100% substitute unless one has a massive portfolio
    Their variability/volatility is a serious drawback
    For many years now in retirement-18-I have gone for total return and sold the requisite number of units of equities and/or bonds once a year from SIPP and/ or ISA to top up my daily living expenses cash account keeping my Asset Allocation intact
    Simple cheap easy to understand especially re tax
    xxd09

  • 24 Seeking Fire April 17, 2021, 6:46 pm

    Hi Ecomiser. You make some good points here particularly with my example but I think the counter arguments are (a) this analysis assumes markets are generally efficient with shares trading at fair value (i appreciate you may not think that – I generally do) and (b) if you hold an index you are simply selling a smaller proportion of your units each year to manufacture the equivalent yield. I gave a simplistic example above to illustrate.

    Don’t get me wrong, I like this quote below a lot. I just don’t see how economically selling units is any different to a dividend being paid, all else being equal. Both are a return of capital.

    “Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” –John D. Rockefeller

  • 25 Al Cam April 18, 2021, 10:24 am

    @Seeking Fire(#24), EcoMiser(#21), et al
    IMO, the late great Dirk Cotton summarised this situation well in his post:
    http://www.theretirementcafe.com/search?q=dividend+fallacy
    Dirk, of course, wrote from a US perspective.
    One notable UK specific point is that holding income units (as opposed to accumulation units) in a GIA can simplify tax reporting.

  • 26 DavidV April 18, 2021, 1:57 pm

    Revisiting some of Lars’ earlier articles, I see that he has addressed my question (5) about bond maturity in retirement in this piece from 2014:
    https://monevator.com/how-should-you-invest-for-your-age/

  • 27 Neil April 18, 2021, 4:54 pm

    I have great uncertainty over implementing Lars’ gilts part of his recommendation. I simply don’t understand the mechanics of which Gilts to buy within a SIPP.

    I dipped my toe in the water in Jan having watched all his vids and bought IGLT (iShares Core UK Gilts UCITS ETF). It’s been anything but the cautious, low-risk, unexciting but wealth-preserving investment I expected, as it’s dropped 5% in 3 months!

    I’ve obviously done something wrong, I can see that, but I don’t understand what. If anyone could share a link on this aspect (gilts investment in your local market) and how it SHOULD be executed I’d be really grateful.

    Thanks

  • 28 The Investor April 18, 2021, 5:05 pm

    @Neil — I can’t give personal advice or say what is right for you specifically. But in general there’s nothing wrong with IGLT as a way of getting exposure to UK gilts. You just happen to have bought into a gilt fund at a time when interest rates have been rising (off the floor) and hence super-safe government bonds have sold-off, which has brought down the value if the IGLT fund.

    To be honest a 5% loss in three months is small beans. An equity fund can lose 5% in a single day, easily.

    Look at this long-term graph of IGLT and you’ll see lots of ups and downs (remember this excludes income paid out, also):

    https://www.google.com/finance/quote/IGLT:LON?window=5Y

    If you had bought at the start of 2019 before the rise you would have done nothing more ‘right’ from the perspective of a passive investor than buying just before the recent falls are doing anything ‘wrong’.

    Remember too that in a diversified portfolio, you should have other assets in your SIPP. Such as equities that have probably been rising. Diversification doesn’t mean everything goes up all the time. It means having a mix of assets where some go up and some go down.

    Finally, if you’re very worried about meaningful but not life-changing amounts of volatility like you’ve seen recently, you could hold cash instead of gilts. With interest rates still very low, it’s a bit of a wash for private investors. Or possibly split your low-return ‘safe’ asset allocation across gilts and cash. (Not advice, just ideas to research).

    This is a very unusual time in history for government bonds, but if you’ve done all that reading you presumably understand they can go up and down just like any other asset.

    Hope this helps!

  • 29 Neil April 18, 2021, 5:17 pm

    Hi, thanks for the reply.

    Looking at the Gilt yields for Gilts maturing in, say,2023, they’re around 0.1% (https://www.fixedincomeinvestor.co.uk/x/bondtable.html?groupid=3). This is what I was expecting, something very poorly paying, but ultra-reliable. That would suit my position, where I don’t care much about this portfolio increasing, but desperately need it not to decrease!

    I could keep it in cash. But my worry here is that it is within a SIPP. My understanding is that if the SIPP platform went under (it’s one of the well-known ones, so I’m not expecting it to) my equity AND gilt investments would (or should!) be fully ring-fenced and protected. But my cash is safe only to the £85,000 guarantee.

  • 30 The Investor April 18, 2021, 5:44 pm

    @Neil — You can typically buy and hold individual gilts in a SIPP. If you want the Gilt 2023 you could (probably) buy that on your platform. Ignoring dealing costs (which might eat quite a lot into your 0.1% return, I’ve no idea) there are things to be aware of though:

    1) In 2023 you’d have to roll your money into something else. Probably another short-term gilt, by the sounds of it. Yields could be higher or lower by then. Either way, more dealing costs.

    2) Please do make sure you understand the maths here. You see that the gilt “UK TSY 0 3/4% 2023” is priced at 101.36, right? It is going to be redeemed at 100. So you are going to lose money on the capital you invest here. You will watch this holding got down in value, albeit only by a little over 1%. At the same time you’ll expect to get that coupon of 0.75%, which is what creates the ‘yield to redemption’, which is listed here at 0.149%. The coupon payments counter some of the capital declines to give that (slight) positive expected return.

    But I would definitely triple check what is going on here. You can see the yields are quite different for apparently similar maturity gilts (okay, only 0.1%, but in this market that’s huge) on that table. What it likely means is that some will have more/fewer coupons left to pay (I’m not an expert). But there’s no free lunch in a huge market like this — big funds would exploit ‘free’ money in super-safe gilts — so I imagine there’ll be some other ‘cost’ in the deal, such as a wider spread than the listed price (reducing your YTM) or other illiquidity (you may not even be able to buy etc).

    From what you’ve written about your requirements it sounds like you should be in cash with this allocation. But that’s your call.

    Another option is a lower ‘duration’ gilt fund, that holds shorter-term gilts. There the volatility should be much lower (and the returns lower too, clearly).

    For instance, iShares has an ETF fund of 0-5yr gilts, to save you the cost/hassle of rolling over as described above.

    See:

    https://www.ishares.com/uk/individual/en/products/etf-investments#!type=all&fc=43631&fac=43515&fsac=43563&view=keyFacts

    I’d hunt around on those pages, and look at duration. It is a measure of sensitive to interest rate changes, which is what is driving the volatility you’ve seen in your holding to-date. The duration of IGLS is 2.53 compared to 11.97 for IGLT. A lower duration number means much lower volatility to changing yields.

    Finally, you’ll be aware that you could ‘lock-in’ your 5% loss if you sell now and the market bounces? Or you could avoid a further 5% loss. I make no comment on what is more likely. Just else something to think about. 🙂

    I am NOT saying any of this is a good idea for you / personal advice. (Sorry, I have to keep stressing this because whereas other readers commenting are just random names on a website and so can say what they like with impunity, I am the proprietor of this domain and I must make sure people realize I’m not giving — and cannot give — specific personal advice).

  • 31 xxd09 April 18, 2021, 8:44 pm

    I have only a little to add to all the good advice you have received above
    As an investor of over 40 years I would advise you to take the long view
    I too have been through Gilt investments as the balance to my equities
    I think my last effort was a short term (5 year)gilt ladder which worked OK -having all the (ups and) downs you have noticed
    Since thenI have used a Bond fund with a different make up-see my post 3
    Whatever you choose it’s a long term play and you have to have the stamina for that
    Equities are on the rise at the moment therefore bonds/gilts tend to fall
    Overall your portfolio should be up if properly constructed
    xxd09

  • 32 Neil April 18, 2021, 9:35 pm

    Thanks The Investor and xxd09. Completely understood that you are not giving advice.

  • 33 Seeking Fire April 19, 2021, 9:05 am

    @Al Cam 25 – thanks your treasure trove continues. the late great dirk cotton says it very well. i seem to remember you had an even better link a couple of weeks ago (or maybe it was someone else) but I forget. Anyway as dirk cotton said I am a major fan of dividend stocks as I think (having witnessed this regularly through my professional career in financial services) it helps management teams to husband cash in a more efficient fashion. I have also seen companies though slavishly follow the need to pay a growing dividend annually to the detriment of their longer term business with sometimes disastrous results.

  • 34 EcoMiser April 19, 2021, 1:23 pm

    @Seeking Fire, @Al Cam etc.
    a) I, and HMRC, disagree that dividends are a return of capital, not least because after a sufficient period (typically 10-25 years) all the capital has been ‘returned’, you’ve still got your capital invested, and dividends continue to be paid.
    b) Dirk Cotton correctly points out that the price of a stock drops by the amount of the dividend, but ignores that the price had been rising by the same amount or more since the last dividend as the company made a profit (all other effects being ignored).
    c) A further difference difference between taking a dividend and selling stock (post 19) is that by issuing a dividend the company has rid itself of £10 surplus cash and reduced its NAV, whereas not issuing the dividend the company has the same NAV, but by selling stock less of it is yours, both the productive assets, and the non-productive cash. It may be that the company could have made better use of the cash if it wasn’t expected to issues a dividend. Had it done so, and you sold 10%, you would now have 90% of a more productive company, instead of 100% of a slightly less productive company. Which is better depends on how well the company could make use of the retained dividend, that is whether it can efficiently grow or is a mature cash-cow.
    d) While shares generally trade around fair value, intra-day variations in price are much more about matching the immediate supply and demand. If 10% of a company were offered for sale, as in the simplistic example used, the price offered is going to drop.

  • 35 Al Cam April 19, 2021, 4:54 pm

    @Seeking Fire (#33); EcoMiser (#34):
    I think SF might just be referring to a link posted by the Rhino at comment #11 in https://monevator.com/weekend-reading-doomed-and-boomed/

  • 36 Neil April 19, 2021, 5:14 pm

    Just as a little follow-up to our mini-thread on buying gilts …

    I looked today at the cost of buying the gilt “UK TSY 0 3/4% 2023” cited by the Investor. Today’s price is 101.37. My SIPP platform, AJ Bell, quoted me 103.76 to buy this!!!! Their spread is 98.96-101.37.

    So buying individual gilts, at least on an AJ Bell platform, is completely unviable.

  • 37 Seeking Fire April 19, 2021, 8:55 pm

    Hi Al Cam. Yes sorry (and thanks to Rhino), I thought that was a good article.

    EcoMiser. Some good points in your article – to discuss your comments.

    (a) When I say ‘capital’ I mean the current value of your investment. I agree your original capital is all returned at some point through dividends. However when we are saying dividends are a return of capital we are saying return of the current value of your investment not original capital.

    (b) Yes agree with you but again we are comparing the situation immediately prior to either a dividend payment or not. If immediately prior to a dividend payment of £2 the stock is trading at £100 when it goes ex-dividend it should drop to £98. If the dividend is not paid it stays at £100. Hence no difference imho.

    (c) yes I agree with your point but I feel you are talking about the future use of a return of £x through a dividend vs being retained in the company. Again the point I am making is just at that precise point in time there is no free lunch.

    (d) agreed if you sold 10% of most companies that would likely mean selling below fair value. Again per previous I assume that companies are trading at fair value when you sell. There are often more frictional costs in dividends (e.g. tax / reinvestment charge if that’s your choice) than selling – that may be less relevant in de-accumulation I appreciate.

    And I also appreciate why many people disagree with this line of thinking which is why UK income trusts and investment trusts are so popular. In addition if it works for the personal investor and they can stay the course who am I or anyone else to say that is the wrong approach!

  • 38 The Investor April 19, 2021, 10:00 pm

    @Neil — Thanks for following up, and yes that was what I expected as mentioned in my comment. I think if you look at an individual gilt maturing five to ten years out the spreads should be much more reasonable.

    i.e. I don’t think it’s an issue of buying individual gilts as such. I believe it’s an artefact of the short-life left and paucity of the cashflows to come on one short gilt vs another in this near-free-lunch-free-super-deep market. (This is where we need @ZXSpectrum48K to pop up. 😉 )

  • 39 EcoMiser April 21, 2021, 12:54 pm

    @ Al Cam Thanks for that link.
    For me that article had a big glaring error. Occam compared taking a 5% dividend with NO actual return, result £95 of stock + £5 cash, with taking no dividend and a 5% return, result £105 of stock. Reality is more likely 5% return and 5% dividend, result £100 stock and £5 cash.

    @Seeking Fire
    However when we are saying dividends are a return of capital we are saying return of the current value of your investment not original capital. That sounds to me like a redefinition to suit your argument. ( I know it’s not your redefinition.) Of course it’s a return of part of the current value of my investment, because the current value includes the proposed dividend.
    To me a dividend is, usually, a distribution of part of the return of the company before it is incorporated into the capital of the company. (And I appreciate that ITs play tricks with reserves to smooth the dividends. I really appreciate it at the moment with a slightly rising dividend income despite all the disruptions to trade currently happening 🙂 )
    I agree that taxes and other frictional costs can make a difference, and going for high yield can mean going for companies with falling prices.
    However, for all the reasons mentioned, particularly the reduced number of shares held, I don’t agree that taking a dividend is the same as selling an equivalent value of shares.

    For me, in decumulation, with Investment Trusts held in an Iweb ISA, there are no personal taxes, no platform fees, and the dividends just appear in my bank account each month. Were I to use a ‘make my own dividend by selling’ strategy, I would be paying transaction fees, AND having to actively sell. That’s deciding how much I need, how often, which shares to sell, checking the current prices, putting in the sell order and deciding, within 15 seconds, whether to accept the price offered, all of which I find stressful, and likely increasingly so with advancing age and senility. That’s why I use a dividends policy, and accept that I could perhaps have made more doing things differently, not any of the reasons advanced in the Occam Investing article.

  • 40 Al Cam April 21, 2021, 3:09 pm

    @EcoMiser (#39):
    No worries!
    Re: “Reality is more likely 5% return and 5% dividend, result £100 stock and £5 cash.”
    I suspect, the reality is more likely x% return and 5% dividend, where x is almost certainly <5%. Agree 0% return is not terribly realistic, but he seems to just be trying to explain that yield and return are different parameters.

    Also, your point about timing (yours vs the businesses dividend payment schedule (with or without IT 'smoothing' and/or other perturbations)) – like a lot of the points in this debate – is a bit of a double edged sword. That is, both approaches have pros and cons!

  • 41 Seeking Fire April 21, 2021, 3:19 pm

    Ecomiser – I don’t think that’s what the Occam article was saying – it was seeking to illustrate the difference between what is yield and what is return.

    Anyway, your last paragraph illustrates to me exactly why your strategy is the correct one. I don’t agree that it is optimal – my biggest concern with it (let’s forget about dividends vs selling for a moment!) is that people investing in investment trusts that pay higher dividends are generally making big sector bets (often without realising it) due to the concentration on sectors paying higher dividends – city of london being a good example. This has been a sub-optimal asset allocation choice over the last few years given generally low tech exposure. But….one shouldn’t let perfect be the enemy of good and so if it works for you that’s fine. I also think your strategy psychologically will work better in a bear market too. So even though I don’t agree, I’m not going to critique if that makes sense – it might well be where I end up in de-accumulation.

  • 42 Naeclue April 22, 2021, 10:20 am

    I don’t have a problem with investment trusts delivering a steady and hopefully rising real dividend stream, but I have a big problem with the fact that they are actively managed. On average active management underperforms market trackers, but it is not the average underperformance that matters as nobody gets the average. Picking actively managed funds runs the risk of significantly underperforming the market and turning what might have been reasonable returns into returns that end up being very detrimental to decumulators over the long term.

    I have just had a look at the AIC stats for equity income funds. UK Equity Income total price return over 10 years 116%. Great you might think, a retiree 10 years ago would have been very happy with those returns. Global equity income managed better, averaging 135%. Until they compare with the MSCI AC World Index which produced a total return of 206%. But then there is the dispersion of returns within these ITs to worry about – what if a retiree picks duds? British&American only managed 15% for example. Let’s not forget either that many of these ITs are leveraged bets. That leverage should have flattered returns over the last 10 years.

    For all I know the next 10 years might deliver market beating returns for equity income ITs, but decumulation is largely about trying to mitigate bad outcomes. In particular trying to mitigate of sequence of returns risk. Investing in ITs increases sequence of returns risk (as illustrated).

    The great stock market returns over the last 10 years would have meant that retirees living off IT equity income dividends should have done ok, but what would happen if we got poor market returns compounded with significant equity income IT underperformance?

Leave a Comment