Stephen Bland reflects on his long-running income strategy.
For a change, because I very rarely write about it here these days, I thought it might be useful to reiterate my thoughts on the High Yield Portfolio (HYP) strategy that I launched here on the Fool all those years ago. Back in 2000 to be exact.
The basic version of the strategy I put forward then, and continue to advocate, is very simple. A sector diversified portfolio of high yielding big caps, minimum fifteen, held for income forever. Holding forever means that shares are sold only when compulsory to do so, such as in a bid or in rare other circumstances when it may be advisable for technical reasons. There is no voluntary trading.
Originally the idea was aimed at income investors, but shortly after it became clear that it could just as well be used by those reinvesting dividends to grow the portfolio for future income.
Why hold forever? This is perhaps the most controversial aspect of my scheme. I know some people are not happy with the rule, because it strikes them as somewhat illogical. As they see it, circumstances change so that the shares should be reviewed regularly and in certain situations, possibly wholly or partly sold and replaced with another.
Circumstances do indeed change, but to explain the reasoning behind this, you need to be aware that my experience of investing includes not only my own lengthy period of following the market, but also an earlier existence of advising others. Consequently, I have been in a position to see a lot of investors over the years and that contrasts with the position of almost all other HYP investors, who can voice only their own opinion or experience on the matter.
The beauty of doing nothing
It struck me quite forcibly that those investors who did nothing over the years performed far better than those who traded. There was a clear inverse relationship between trading frequency and success. The greater the trading, the poorer the results. Later, I saw this confirmed by some brokers.
Now this is not an infallible relationship. A tiny minority of traders do alright, while a small number of long-term holders do poorly. But it is a strong general trend. It says that the typical private investor is poor at making trading decisions, and that is why the typical private investor does not make decent money from the stock market, either from capital or income.
How do you know if you are in the small minority who can win, or the large majority who will make poor decisions? Well sheer math from what I've heard says that you are probably worse than ten to one against winning with trading than eternity holding. But apart from the math, be honest with yourself. Do you have a history of successful trading of anything? Do you have a nose for what works? If you are that good a trader, why bother with such a pedestrian strategy like HYPs which are for income? Trade derivatives and quickly make a fortune.
The other reason I went for a no-trading approach is that that the whole strategy is designed to be left alone for long periods. A HYPer does not need to know their portfolio value constantly, because capital is almost irrelevant, or follow every bit of news, almost all of which will be inconsequential in the long run. If though you are concerned with trading, it needs following. Doing nothing is the best advice for the HYP strategy, but that's hard for a lot of investors to take, especially men it seems.
The test of time
A lot has happened in the period of over eleven years since I began, the most serious being the credit crunch and ensuing recession. A baptism of fire. This had a major negative effect on a lot of shares, especially those of a financial nature or connected with property, but also on a number of others, too.
Such events are pretty rare. The last one I recall of this magnitude, with property collapses and leading banks going bust etc. was in the early 1970s so we're talking 35-40 years ago. I'm not saying there is a regular cycle of that length, but I am saying that these really serious crashes have happened before. I am certain they will happen again, though I can't know when. They are, however, infrequent.
Do these events invalidate the HYP approach? Definitely not. My insistence on wide sector diversification is the defence. HYPers will suffer during these really bad times from widespread dividend cutting and suspension. Maybe they will even lose a share permanently to going bust. So total portfolio income will fall and that is unavoidable in the poorest years. The strategy is not for people who cannot live with that possibility.
A lack of interest
But note that income from variable interest sources will also fall, because interest rates collapse in a recession. Investors relying on bank interest have seen their income fall dramatically over last few years, by a much greater proportion than the income from HYPs. In my experience, bank interest is a major source of income for a lot of people. Understandably they like it for the reason that there is no risk of capital fluctuation. It's a powerful argument for many.
However, interest rates are a lot more volatile than HYP income, which has proven far more stable, even with the sort of falls we've seen. There are times when interest rates are higher, and times, like now, when they are lower than HYP income. But the fluctuations are much greater and must be hard to take for someone dependent on that interest.
I'm getting on in years myself now. Alright forget the euphemisms, I'm ancient. And I have no hesitation about sticking the great majority of my investment capital in my HYP, out of all the income choices I could make. A money and mouth job. I never believed that view of some advisers about the older you are, the less you should be in equities for income. I find the opposite to be preferable, with the HYP structured approach to equity designed to lower the risks.
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