A big theme in the post-crisis years has been the hunt for a higher income yield – including the yield you get from dividend paying shares.

This love of dividends has been quite a turnaround from the decades prior to 2007 and 2008.

For most of my life, dividends were about as fashionable as flared denim.

But apparently even flares are due for a revival – and dividend investing long ago recaptured the heart of the mass investor.

The most obvious cause is six years of interest rates at record lows. We’ve even seen negative yields on some European long bonds.

Near-zero interest rates sent would-be cash savers into bonds, and in turn the more adventurous would-have-been bond investors into so-called ‘bond proxies’ – dividend-paying shares in relatively stable and defensive companies (or ‘quality’ stocks as we now seem to call them) such as food producers and utilities.

I also think the accounting chicanery and financial engineering of the last boom caused people to reconsider the virtues of real cash paid by real companies.

Whatever the reason, we’re all John D. Rockefeller now.

The legendarily wealthy tycoon once quipped:

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

From discounted goods to premium produce

Of course, investing for dividends never actually went away.

Neil Woodford – probably the most popular UK fund manager of his generation – built his career buying unpopular stocks for income. In his pomp at Invesco Perpetual, Woodford was running nearly £25 billion in income orientated money.

But in recent times more and more generalist fund managers also began praising the virtues of dividends.

We’ve even seen venerable trusts like RIT Capital Partners explicitly change its mandate to target higher dividends in the future. (RIT is a Rothchild family wealth vehicle, and those guys didn’t get to where they got without having a nose for fashion in finance.)

Another place where the popularity of income investing has shown up is in equity income investment trusts.

During the crisis I was able to flag up such trusts trading at double-digit discounts.

A discount indicates that you are paying less than the underlying holdings of the trust are worth – a bit like buying £1 coins for 90p.

Such “really?” sized discounts are not unusual with, say, private equity trusts – where people may have doubts about the true value of the trust’s holdings – or with trusts where a major shareholder is potentially distorting the playing field.

But for veteran UK equity income trusts holding bog standard blue chips, it was pretty unusual.

Most such trusts have a very good record, are well-managed, and you’d expect the dividend payout to provide some valuation support in comparison to a non-dividend paying trust, because with an income trust, the wider discount, the greater the effective yield you get paid from the underlying assets on your initial purchase.1

Sure enough, the big discounts didn’t last long. The trusts were soon trading at a premium, as that hunt for yield I talked about kicked in.

Indeed over the past few years I’ve heard investors wondering whether they’ll ever get the chance to buy UK equity income on a discount again.

For a while it seemed unlikely. But nothing lasts forever in investing.

The premiums have actually been coming down for the past year or so until… here we are, with the majority of UK income trusts on a discount again.

Income investment trusts on special offer

True, we’re not (yet?) talking double-digit discounts, but the trend from trading at a premium to a below-par discount is clear in most of the popular trusts.

Look at the graphs below that I’ve pulled from AICstats (an excellent source of data on investment trusts of all flavours).

All these graphs cover the five-year period from Spring 2010 to May 2015.

I’ve also included the dividend yield as per yesterday’s close.

Edinburgh Investment Trust – 3.5% yield / 4.1% discount

Merchants – 5.0% yield / 5% discount

Temple Bar – 3.3% yield / 5.9% discount

Standard Life Equity Income – 3.5% yield / 8.9% discount

Invesco Income Growth – 3.5% yield / 7.5% discount

Lowland – 2.8% yield / 8.2% discount

Perpetual Income & Growth – 3.0% yield / 4.4% discount

A couple of income trusts still trading on a premium… just!

Not every income trust is trading below its net asset value, but it’s close.

And even where premiums are in place they are slender, as typified by the venerable City of London trust and by cult fund manager Nick Train’s Finsbury Growth and Income trust:

City of London – 3.8% yield / 0.7% premium

Finsbury Growth & Income – 2.0% yield / 0.3% premium

Fill your boots?

The obvious question is why most income trusts have gone from sporting big premiums to discounts.

I don’t know the answer, although I can think of plenty of potential reasons:

• Some of these trusts have had a recent poor run (e.g. Temple Bar, which I have bought myself for that reason, among others).

• The shine has come off some – not all – bond proxies (Diageo springs to mind).

• Investors have grown wary of chasing higher prices, even where the trust’s underlying assets have continued to pile on the pounds.

• The post-RDR focus on costs that gave investment trusts a moment in the sun has passed.

• The bonds-for-shares trade is wearing thin (everyone who might make the trade has done it?)

• Supply and demand: The growing popularity of index funds and ETFs (including some ETFs that explicitly focus on income) is reducing the appetite for investment trusts.

• Bond yields have bottomed, and that’s feeding through into reduced demand along ‘the curve’.

None of these explanations is wholly satisfactory to me.

For example, while I suspect the bond mania may have seen its last full-on hurrah, until very recently yields were at record lows – yet some of these trust discounts have been blowing out for a while.

On balance I think the UK election is a plausible cause.

It might not seem to make much sense, because these trusts are overwhelmingly investing in large multinationals that get most of their income from overseas.

However I’d bet a majority of purchasers of UK equity income trusts are British, and there are reports that UK investors are curbing their enthusiasm due to the election.

So is this a buying opportunity?

I must admit my crystal ball is on the blink.

It’s not inconceivable that the canny market has sniffed out the end of ‘reaching for yield’ long before market pundits and humble bloggers like me have noticed.

In that case discounts on income trusts could continue to widen. Their returns versus the market could be dampened still further by a relative sell-off in the higher yielding stocks the trusts own, too.

And of course the market could crash at any moment, like always. Old age doesn’t explicitly kill bull markets, but it does bring the day at the knackers yard ever closer.

All that said if you’ve been waiting to invest in equity income trusts on a discount simply because you don’t want to overpay on principle, your moment has arrived.

But be aware that doesn’t mean it won’t arrive some more.

1. I’m not saying that’s logical: You still get a higher ‘earnings yield’ from non- or low-yielding trusts. I’m saying it’s how the mind of an income investor works. [↩]

Yet another story about a venerable old millionaire who people presumed was poor while he was still alive.

In The remarkable life and lessons of the $8 million janitor, the Washington Post tells us:

Despite his relatively modest wages, Read left an estate with “stock holdings and property” valued at nearly $8 million

One of my friends saw the piece and emailed me:

A glimpse of the future…

Are you worried that Ronald Read could be you in a few decades? 🙂

I quipped back that if I made it to 92 and I only had the equivalent of $8 million to my name then something must have dramatically changed along the road.

In fact, I’d say I’m on-track to have north of $300 million by my early 90s.

Many happy returns

That might seem an outrageous sum of money. Yet the maths behind my whimsical reply is pretty straightforward.

Despite rarely paying any higher-rate tax in my 20-odd years of working – and only modest amounts then, although recently I’ve been shielding more of my earnings behind a SIPP anti-tax wall – I have saved diligently all my life, and I’ve invested obsessively for nearly 15 years.

To cap it all, I’ve never bought the flat that this money was initially meant to go towards. Instead the snowball has just kept on rolling.

To-date it has me with a healthy six-figure sum – though that’s hardly sensational in the context of two-bedroom flats in my area of suburban West London, which cost well north of £500,000.

So how do I get from here to my mooted Scrooge McDuck-style fortune?

• For the sake of argument, I assume I will continue to save and invest as now until 67.

• At that point I assume no more fresh savings, but that I continue to invest at the same rate of return until I’m 92.

• I am using a rate of return that is a few percent ahead of the return from UK shares over the past 100 years.

• That’s controversial, but I believe it’s below the rate of return I’ve achieved so far. (I can’t be totally accurate because my early records are hazy as I don’t really believe in tracking returns. So it’s a conservative estimate, based on eyeballing those figures I did record and guesstimating. I have accurate records for recent years, as I decided I shouldn’t be opining about investing publicly without knowing where I stand.)

• I assume today’s £/$ exchange rate prevails when I’m 92. This turns £200 million into $300 million.

• Finally, I’m ignoring inflation (£200 million when I’m 92 will be worth far less than it is today).

I am deliberately being vague with my age, savings, and my investment returns for three reasons:

• Privacy.

• Because Monevator isn’t specifically about my achievements (or failures!)

• Finally, because this is just a silly hypothetical example, not a realistic investing plan. Let’s not sweat the details on a thought experiment.

With those assumptions and caveats, I find a quick play with our compound interest calculator gets me to £200/$300 million at 92.

And by far the most important of those numbers is the last.

Golden oldies

It’s seeing my 90th birthday without drawing down my portfolio that’s really the secret of my hypothetical future self’s awesome investing success.

Pretty ironic – because I bet the journalists of 2060 will ask me all about my stock picking techniques and my ability to live frugally…

…but nobody will ask me about my diet or my fitness regime or how long my father lived, even though these will be as relevant to their story.

Old age is the extra leg up for most globally famous super-wealthy investors.

I’ve pondered before whether great investors live longer. I considered many of the attractive side-benefits of the lifestyle before concluding:

It could be that a long life is required to generate their truly incredible investment returns, rather than the latter causing the former.

And I think that is usually the case.

In the (totally theoretical) example we just ran through, I’d retire to live off a state pension at 67 (albeit doubtless topped-up by the thoughtful treats and home-cooked fare of kindly descendants who have one eye on my fortune).

At that stage, I’d have about £12 million. Nice, but it’s not going to get me onto any Rich List.

The other £188 million of the final £200 million comes from compounding that £12 million during my elderly years into an eventual nine-figure fortune.

It’s the same with most of those famous old investors like Warren Buffett  – and also the fabulously rich nonagenarian janitors and nurses we read about.

Sure they were already loaded by the time they became eligible for a bus pass.

But the crazy numbers that make our eyes pop?

Those came later.

Who wants to be a millionaire?

To me it’s almost more shocking that there aren’t more silver-haired and Zimmer Frame sporting Millionaires Next Door around, when you consider the maths.

Let’s turn again to Ronald Read’s stash. How much would you need to match his $8 million, in today’s money?

Remarkably little if you live until 92, with even just average stock market returns.

We’ll call $8 million equivalent to £5.3 million, as per today’s exchange rate.

Let’s say you reached 30 with savings of £20,000.

You invest it all in the stock market.

You fill your ISA every year for the rest of your life (so that’s £15,240 a year).

We’ll say you achieve a real1 return of 4.5% a year. (That is lower than the historical real return from UK equities over the past 100 years or so.)

At aged 92 you’ll have £5.3 million in today’s money.

Here’s a pretty graphic from the Monevator compound interest calculator that shows how your pot grows:

Ifs and buts

You can pick all sorts of holes in this example, obviously.

You might say an expected 4.5% real return is unrealistic, even though it’s lower than the historical average.

I disagree and think there’s plenty of reasons to be optimistic about the future (although I would concede that environmental collapse might make it all moot).

You might say it’s going to be hard to fill your ISA if you retire at 67, say, but remember I’m not up-rating that £15,240 contribution with inflation.

£15,240 will likely be quite a trivial sum in four decade’s time, let alone six.

You might also argue that ISAs won’t be around, or start muttering something about the Lifetime Allowance in a pension being capped at £1 million.

Clearly, sheltering your returns from the impact of tax – whether in such vehicles or by rolling up capital gains – will be vital to achieving a big final number.

I agree the landscape will change out of sight between now and then, but we can presume it won’t all be for the worst. Besides, this is just a thought experiment.

The point is it’s not impossible for an averagely high-earning 30-something to be fabulously wealthy when they die, provided they save and invest remorselessly and live until they’re 92.

What about someone who isn’t earning so much? Perhaps somebody living a healthy opt-out lifestyle whose frugality still enables them to salt a bit aside every year?

How much do they need to invest to make a million in today’s money by 92?

Not as much as you might think.

In fact, if they started with a £25,000 nest egg saved up from their previous life in the rat race and then managed to squirrel away £2,000 a year on top, with the same 4.5% real rate of return they could be a today’s money millionaire at 92.

And given their low stress living, you might also think they’d be more likely to make it into their 90s…

The wrinkle

Of course, that’s the rub.

In reality most of us choose to use most of our money to improve our quality of life while we’re alive – and nobody lives for ever.

That’s probably why most super-rich investing millionaires are either market professionals or else monomaniacally obsessed amateurs. They are investing for reasons other than simply to improve their lives in a decade or three.

Everyone else has kids, aspirations, spouses, and material itches to scratch.

Still, unlike some I don’t shake my head when I see somebody die with vast wealth that could have enriched their lives while they were alive (or the lives of others such as the person thinking the thought, which I believe is often the motivation for it!)

The author of the Washington Post op-ed makes some salient points in this regard, but generally people are dismissive of “miserly” old millionaires.

For instance the so-called Tin Can Millionaire – a Swedish tramp who died with over £1 million in the bank – attracted a lot of finger pointing.

On the face of it it’s obvious he should have spent more money along the way.

But who knows how amassing and investing his growing fortune motivated him, or what comfort he derived from knowing it was there?

Money is strange stuff. I’ve warned before about the dark side of compound interest – exemplified by Warren Buffett refusing to buy his wife a sofa in the 1950s because he was mentally extrapolating what it would cost him in investment gains foregone over 50 years.

Even Buffett talks explicitly in one of his early partnership letters about the futility of chasing money for an entire lifetime, and his desire to someday do something different.

Many would say he spectacularly failed to achieve that ambition, given he’s ended up as one of the richest people in the world.

But he’s lived to 84 and he got rich young and financially savvy.

After that he was always likely to die very wealthy.

Compounding the 1%

Folk tales of very old millionaires remind us of the awesome power of compound interest when allied with equity investing, but they don’t tell us a great deal we can put to practical use – except to start as young as you can.

Begin investing at 25 or 30 and you can hopefully get usefully rich by your 50s or 60s, rather than in your 80s or 90s. Kids whose parents are opening and funding pensions for them could be laughing in six decades time.

Incidentally I’d also caution that this dynastic dimension is why more of you should start agreeing with me that inheritance taxes need to be a bigger piece of the taxation picture.

The rich are getting ever richer. That is totally fine with me when they earned it, but I’m less comfortable with their wealth “cascading through the generations” than many of you are, partly because of this snowballing affect over a sufficiently large time frame.

In the old days you could rely on every second or third generation to blow the family fortune on fast cars, loose women, or trying to be a pioneer in aviation.

But the scions of wealthy families seem to be far more responsible nowadays. Risking a few years and a few grand trying to start up a business in Silicon Roundabout is more their style.

This matters because Ronald Read left his fortune to charity, not to Ronald Read Junior who could compound it for five decades before passing it on to Ronald Read III – a process that extends out the frankly impossible horizons of 60 years or so to trivial timescales for a typical old money family investing office.

Read up on Methuselah Trusts if you haven’t ever considered this dimension.

I’m risking venturing into politics here and we had enough of that last month, so let’s leave what to do about the societal downsides of compounding massive sums for another day.

Double or quits

For now I say we investing enthusiasts should salute the super rich janitors of the world, learn from their discipline, but also ask questions not of how they spent their money but what we’d do in their shoes.

How much is enough and how long have you got?

Impossible questions to answer, and supremely important.

For my part I don’t expect to see my 92nd year, given that 70-odd is an almost unheard of innings for men in my family.

(Get out the tiny violins!)

But if I do, it won’t be with £200 million to spare.

I’ll have turned on the spending spigots far too soon for that.

For starters I’ll have a London flat to buy… 😉

1. That is after-inflation. [↩]

Good reads from around the Web.

There’s a lot to enjoy in Morgan Housel’s useful reminder that buying the stock market in 2009 wasn’t “easy money”, but I especially liked his sample of all the claims in the subsequent years that the buying window had closed:

Barron’s, Nov. 2009: “The Easy Money’s Been Made”

Morningstar, Dec. 2010: “The Easy Money Has been Made”

MarketWatch, Nov. 2011: “The easy money has already been made”

TheStreet, May 2012: “The Easy Money Has Been Made”

Morningstar, Dec. 2013: “The Easy Money Has Been Made”

Barron’s, Oct. 2014: “The Easy Money Has Been Made”

CNBC, March 2015: “The easy Money has been made”

Do read the rest of Morgan’s article at the US Motley Fool website.

At this point my ego obligates me to mention that (by fluke!) I caught the bottom of the UK market to the day when I wrote in March 2009, :

Ultimately, if you’re not trickling money into the markets at these levels then I think you might as well forget stock market investing altogether.

I could dine out on this, but even this extract gives us a clue that there was nothing easy or legendarily prescient about this call.

I am talking about “trickling” money into the market on the cusp of the buying opportunity of a lifetime!

What a muppet.

More importantly, I’d been buying throughout the bear market in the months that proceeded the low (having, again partially fortuitously, turned quite a bit to cash in 2007, motivated by the need for a deposit for a house I never bought).

I also remember – because I was both buying and blogging at the time – that everyone hated the stock market back then, including many who today write like they saw the imminent rally coming in 2009.

Don’t believe them. Most of them were fearful, and nearly all of them didn’t.

And incidentally “fearful” isn’t a criticism here.

The best of them – of us – were fearful.

You had to have the right mindset to be buying in 2009. You had to know that equities have suffered severe reversals many times before, and you had to believe that this one too would pass – that capitalism wasn’t headed for the scrapheap.

And then you had to be humble enough to hold on.

It wasn’t easy to cross your fingers and buy in 2009.

But arguably it’s been even harder to stay humble and remind yourself again and again that you really don’t know what will happen next as the good times have rolled on – especially as all investing involves asset allocation decisions and taking a view, if only about your risk tolerance.

Easy peasy?

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