Having enough to live on until the day you die – that has to be the clear and unfettered goal of every retiree. Only when that objective is secure can we move on to grander visions of a golden retirement, or passing on an estate.

As they say in Alien: “All other priorities are rescinded.”

I’m dealing with this now as a close relative of mine needs help to make safe her income. She’s up against the ravages of inflation, a Darwinian stock market, sharky financial advisors, and a risk tolerance lower than a nun in Caesar’s Palace.

She doesn’t have a defined benefit plan, or sources of income beyond the state pension, and her pensionable assets are modest.

Making a happy retirement out of that lot can be done but it will be touch and go. We will have to put the chips on the right squares and there will be no second throw of the dice.

What really matters?

Daunting choices and goals have been swirling around my relative, leaving her frozen in the fog. What’s needed is a retirement plan filter to help her see clearly.

Here’s what I’ve come up with:

• How much you got? In pensionable assets and any other income that will help your retirement. For many people, “other income” will just be the state pension.

• How much you need? What’s the minimum amount you can live on and be reasonably happy? I’m not talking breadline bleakness here but jetting to Capri on a whim is probably out, too.

• How much you want? Okay, here’s where those Capri weekenders come in. What other lifestyle goals and dreams do you have. For example traveling the world, passing on an inheritance, and so on.

Once you have the answers to these questions you can set about your strategy.

The least risky options available are outlined by William Bernstein – the renowned passive investing champion – in his excellent book, The Ages of the Investor.

Bernstein counsels a two-part retirement strategy:

1. Create a minimum income floor – This aims to meet your basic retirement needs for the rest of your days, and is generated using near risk-free assets.

2. Create a risk portfolio for the fun stuff – Legacies, Gucci bags, and bionic parts are funded by (hopefully) the rise in value of this portfolio. As the name suggests, you can afford to take more risk here because your basic needs are already secure. Though some of the risk portfolio should always be in cash to handle emergencies.

Critically, by ring-fencing the two parts of your retirement plan, you won’t endanger your survival income by taking risks in pursuit of the good stuff.

In this follow up post, I take a look at the best options for nailing down that all-important income floor.

Take it steady,

The Accumulator

Good reads from around the Web.

You can’t turn on the TV or read a business website without stumbling across an economist these days. The financial crisis took these nerds-turned-superstars off the sidelines and onto the front pages.

Why did economists become our go-to pundits? Because we demanded explanations for what happened in the meltdown, and economists fell over themselves to give them.

Sadly, as my post of the week from The Atlantic explains, while economists might be pretty good historians, they’re rubbish at proposing useful actions or predicting the future:

Imagine you are the Royal Physician in England some time during the 14th century. The prince is sick, and you’ve been summoned to help. You call in two experts for advice. The first says: “Use leeches to suck out the evil humors.” The second says “No, you must bleed him to get the evil humors out.” They start to argue, insulting each other in nasty epistles. “Leech guy is secretly working for the French!” alleges Bleeding Guy. “Bleeding Guy just wants the prince to die because the prince wanted higher taxes on the nobles!” Leech Guy fires back.

What’s the right move? Well, in an ideal world, you would go and get 999 patients who have illnesses similar to the prince’s and give them all a variety of household substances, such as bread mold. Then you would take careful note of who died and use statistical analysis to figure out which household substances cured disease. Thus, you would discover penicillin and invent modern medicine.

Sadly, this is not what you do, because a) if you proposed it, you would be led off to the dungeons and beheaded b) it’s the 14th century and you have no concept of the scientific method and c) you don’t really have the right tools for that experiment, anyway. Instead, it’s bleeding or leeches. So you take your best guess and you pray you’re right.

The economic situation we find ourselves in today is a little bit like the example above.

I’m skeptical when I hear an economist explain what’s going to happen in the economy. After many years of reading their opinions, not one has struck me as generally right.

Some, such as the perma-gloomy Nouriel Roubini, seem to be like the sacrificial virgins of our forebears. When the market falls they are given airtime to appease the Dark Lords of Doom, but once the Apocalypse is postponed, they’re returned to the dungeons.

Lots of investors say they don’t take economists seriously, but my experience says otherwise. From 2009 to 2012 I was regularly emailed economic predictions – invariably pessimistic – from investors I know. Comments left on this blog were similar.

Like porn stars, somebody must be using their services and paying for them, whatever they say in public, or else the economist industry wouldn’t be so big!

I rarely include economic prophesies in Weekend Reading. But I do think economists can be helpful to get a view (not *the* answer, and not a prediction) on what’s already happening in the economy, or in a specific sector.

Economists are most useful at explaining recent changes on the bottom-up level – the pent up demand for UK housing, say, or the way that employment is rising despite the weak economy.

Just don’t let them get their crystal balls out.

[continue reading…]

Time flies when you’re running a high-yield share portfolio that – by design – you only look at once every few months or so.

Just one year ago my demo HYP was celebrating its first baby steps.

And those steps had been of the clumsy and stumbling kind.

The portfolio’s value was down 6.6% (ignoring income) since I’d had the bright idea to put £5,000 into it back in May 2011. The wider market was down by roughly the same amount, too, and so was the basket of three investment trusts that I picked for a second benchmark.

A year and a bit on, however, and things are looking far brighter. That’s share investing for you!

Below I’ll report how the terrible twos weren’t so terrible for my demo portfolio, which has grown nicely over the last 12 months.

Before that, I’ll share a few links to answer some of the questions you may have.

• How I picked the shares in the portfolio.

• Why I’m NOT reinvesting the income

• The chosen benchmarks for the HYP

• Why I don’t intend to trade this HYP much

You can also read and bookmark all the articles about this HYP.

Note: I stress again this is a demo HYP. It is not a reflection of my entire investment strategy or asset allocation – it’s a small real money side portfolio created for interest and education for us on Monevator. Please don’t get hung up on the £5,000 invested figure, as that was just what I chose to commit for tracking purposes. In real-life I wouldn’t consider running a HYP like this with less than £20,000 invested, and £50-100,000 would be more like it.

The HYP valuation: Two years (and a bit) in

So where do we stand after year two? That’s the critical question, and sadly I forgot to ask it until four trading days had passed since the anniversary of the last snapshot on 10 May 2012.

What a muppet! I put real money into this demo to make it easier to track, and I keep forgetting to check-in on the anniversaries.

Last year I overcome my forgetfulness by painstakingly recreating the entire portfolio from historical prices and then crosschecking them with a second source.

This year I’m afraid I didn’t have the time. May was just a madly busy month.

So instead, I’m going to report where the portfolio (and the benchmarks) stood at close of play on 16 May 2013. That’s a few days more than a full year.

It’s not a big difference – the UK market moved less than 1% in the interim – but I suppose I can’t now be quite as outraged as The Accumulator gets about sloppy reporting from funds. It’d be a tad hypocritical.

Anyway, here’s where the portfolio stood at the close of 16 May 2013:

Company	Price	Value	Gain/Loss
Aberdeen Asset Management	£4.73	£505.62	102.3%
Admiral	£12.62	£179.30	-28.3%
AstraZeneca	£33.90	£271.49	8.6%
Aviva	£3.47	£195.35	-21.9%
BAE Systems	£4.06	£308.54	23.4%
Balfour Beatty	£2.26	£171.23	-31.5%
BHP Billiton	£19.12	£199.33	-20.3%
British Land	£6.39	£267.16	6.9%
Centrica	£3.87	£306.62	22.7%
Diageo	£20.51	£411.57	64.6%
GlaxoSmithKline	£17.08	£323.81	29.5%
Halma	£5.26	£353.70	41.5%
HSBC	£7.49	£284.89	14.0%
Pearson	£12.04	£264.67	5.9%
Royal Dutch Shell	£22.86	£257.06	2.8%
Scottish & Southern Energy	£15.93	£300.48	20.2%
Tate	£8.62	£351.85	40.7%
Tesco	£3.74	£226.46	-9.4%
Unilever	£28.40	£357.39	42.95%
Vodafone	£1.97	£291.50	16.6%
		£5,828.00	16.6%

Note: The portfolio was purchased on the morning of 6 May 2011, with £250 invested into each of 20 shares. All costs (stamp duty, spreads, and dealing fees) are included.

By the one year mark on 10 May 2012, my invested capital had fallen from £5,000 to £4,670. By 16 May 2013 it had grown back to £5,828.

That means we saw a year-on-year capital gain of roughly 25%.

Looking through the portfolio’s holdings, I still regret picking two insurers, though that’s hindsight speaking. On a brighter note, Tesco had recovered substantially – it was down 22% last year on my initial purchase price. (Since this snapshot it’s fallen back again. Every little helps? Not here!)

The big winner of the year was Aberdeen Asset Management. Its share price doubled on the back of rising markets.

If this portfolio does well over time then critics will say I was lucky to pick shares like Aberdeen. Such criticism is valid, but it’s also missing the point. This is an actively constructed portfolio, not an index fund. It will have a skewed result. That’s the risk you take, and that you’re potentially paid for.

Also I have never seen a portfolio of shares that didn’t show big gaps between the best and worst performers after a couple of years. The same would be true in an market cap weighted index fund, for that matter.

Buckle up! After 5-10 years the gap will between the leader and the laggards in this demo HYP will be several hundred per cent or so.

Benchmark 1: The iShares FTSE 100 tracker

As outlined in my benchmarking article, I will compare the progress of my demo HYP against two alternatives – a cheap ETF, and a trio of investment trusts.

Remember all these returns will be capital returns only, as with the demo HYP.

The ETF benchmark is a hypothetical £5,000 that was invested into 836 shares ¹ of the iShares FTSE 100 tracking ETF ISF, acquired via Sharebuilder.

As previously discussed, the ETF shares were notionally bought at £5.98 per share. The (tiny) purchase costs were taken into account, and there was no stamp duty to pay.

Here’s where the ETF stood at close of 16 May 2013.

Company	Price	Value	Gain/Loss
iShares FTSE 100 ETF	£6.72	£5,614.54	12.3%

Note: Prices from Yahoo.

The ETF has not yet recovered as much as the HYP from its first year fall. Not surprising given the dash for yield we’ve seen in the markets in the past 18 months.

Benchmark 2: A trio of income trusts

I also follow three income investment trusts as an alternative to the HYP.

Again I assumed these were bought via Halifax Sharebuilder, and again I averaged the opening and closing prices on 6 May 2011 to get the initial buy prices. Stamp duty and a penny spread on each trust’s price were factored in.

Here’s where a hypothetical £5,000 pumped into these three trusts stood on 16 May 2013.

Trust	Price 2	Value	Gain/Loss
City of London IT	£3.65	£2,000.26	20.0%
Edinburgh IT	£5.92	£2,086.25	25.2%
Merchants Trust	£4.80	£1,878.14	12.7%
		£5,964.65	19.3%

Note: Prices from Yahoo.

Equity income trusts have been on a tear this year – it’s that chasing dividend income theme again. Discounts have closed, and in many cases income trusts have stood at significant premiums to their assets for long periods.

This has boosted the share price return of the trusts over this period, and thus the performance of this basket over the demo HYP. The situation will likely reverse if dividend income goes back out of favour, and the trusts fall to a discount. They will have many shareholdings in common, after all.

I think investment trusts are a good halfway house between being an enthusiast who fancies managing a portfolio of shares, and a passive investor who invests via an ETF or tracker fund.

So far that’s playing out with a superior return for the trusts, even after their management costs.

The trusts offer a more stable return than the DIY portfolio, too. They are more diversified. They also hold a cash buffer to top-up payments in the lean times.

If you want the same safety net for your own portfolio – perhaps because you plan to live off investment income – then you need to build-in your own cash buffers. This will effectively delay when you can start drawing an income by 6-12 months, since you’ll need a tranche of cash to load up your buffers.

Income comparison

So much for capital, what about the all-important income?

• For the HYP, I simply added up all the dividends I received over the period 11 May 2012 to 10 May 2013.

• For the hypothetical ETF and trust holdings, I went through the dividend records (via the Digital Look and the iShares website) and added up their payments due over the same time frame.

Here’s what each system generated in income over the year:

	2012	2013	Change	Purchase yield 3	Current yield 4
HYP	£181.95	£229.19	26.0%	4.6%	3.8%
ETF	£155.05	£172.11	11.0%	3.4%	3.1%
Trusts	£183.56	£245.52	33.8%	4.9%	4.1%

Note: Yields are rounded to one decimal place.

This is the first full year where all payments made were due to the portfolios, which is why some of the year-on-year gains in income are so large. (Last year’s income figures were subject to a few ex-dividend dates that fell before the investments were made).

This means we can now see exactly what each portfolio paid out in income over the 12 month period.

So far the trusts are doing very well on an income basis, too. We’ll have to see what happens over the longer term.

Needless to say, the current yields on all three portfolios are still much higher than you’d get on bonds or cash.

Finally, while a HYP is an income strategy and I wouldn’t recommend it for total return, I know many of you are curious about how the demo HYP would grow if you reinvested the dividends each year.

That’s a whole new kettle of fish (or more accurately a can of worms) which I’ll look into in a follow-up post.

1. Well, 835.87 to be precise. Halifax Sharebuilder let’s you buy fractional holdings of shares. All my demo HYP shareholdings are fractional, too. I use the fractional shareholdings in the return calculations.[↩]
2. I’ve rounded these here for clarity, but have used the exact price in my spreadsheet.[↩]
3. The last 12 months of income divided by the initial £5,000 invested.[↩]
4. The last 12 months of income divided by the portfolio value at year end.[↩]