If you're investing for income for the long run, fluctuations of capital should not matter.
This question is debated frequently on the High Yield Portfolio board. It arises because as I have always said about the strategy, it is principally about income. The history of HYPs here is relevant to this because when I launched the strategy on the Motley Fool many years ago, it was originally as an approach for income investors.
Later, when it became apparent that high yield shares can deliver on capital as well as income, the strategy became popular with savers regularly adding new capital who, not requiring immediate income, reinvest the dividends to boost the growth. Eventually they will need the income and can then switch to withdrawing it at will without problem or cost.
For both groups though, savers and income investors, does the capital matter? Some claim it does, some that it doesn't. To discuss it I need to define "matter" here because the interpretation is relative, varying between one investor and another though it does have an absolute sense as well. It would be foolish of me to claim that it never matters at all. Taking it to the extreme, if the capital of an HYP fell to nil, there would be no income either. So yes, capital does matter in the absolute sense that you need it in order to produce any income whatsoever. But I don't think that's really the question being raised. What is really being asked I think is whether the inevitable fluctuations matter, together with the associated risk that it will not perform as the investor might hope over the very long time period concerned. That's how I'll interpret "matter" for this article.
The two groups of investors may see the question differently. An income investor is concerned with obtaining a rising income over time, probably the rest of their life and preferably of course in real terms too. What happens to the capital is very much secondary in their case. Assuming the income does the business, yes it would be nice if the capital beats the market long term, but if it doesn't quite do that, well, so what?
I believe that long term the capital will at least maintain its real value, whether or not it beats the market, but clearly there is the chance that it may not. This is a risk strategy after all which investors must accept. But I don't think that the capital should matter much to the income investor, neither its actual value at any moment nor the fluctuations in between.
The HYPersaver can see it somewhat differently because their goal is not immediate but future income. Consequently capital performance may appear very important and the current income, many years prior to drawing it, relatively unimportant. But it shouldn't be seen that way, and this point is crucial for savers, provided it is intended that the future income will be derived from that HYP which they have constructed over the years.
If on the other hand savers don't intend to use their HYP for income but are using it to accumulate capital in order to reinvest in a completely different source for income, or maybe for some alternative purpose altogether unrelated to producing income, then I suggest they are using the HYP approach wrongly. I don't advocate its use for anything other than delivering income in anticipation of future income from itself as far as the investor is aware.
When that future arrives, then the investor can then do what they want with the capital. But I'm saying that the attitude during the saving period ought to be one where the intention is to create a future income from those actual investments being made at the time, not for the creation of a general lump sum.
Utilised this way the emphasis for savers is upon portfolio income and not capital. The fluctuations of capital cease to matter when they realise they are not saving up for a particular capital sum but for a future income from those investments they are now making. The HYP should be seen as forever, whether reinvesting or drawing dividends. All you are doing is making a switch from one mode to the other. Whichever, capital doesn't matter.
I realise of course that nobody likes to see their capital falling and similarly we all get a kick out of it rising. It is very hard for HYP investors to ignore capital value, although one way as I have said repeatedly is not to monitor it. But I see a difference between those who are aware of it and just accept it as an inevitable consequence of the strategy, realising that it doesn't matter and needs no action, and those who think it matters and act negatively as a result. The latter are not really HYPers and will be disappointed with the approach. It won't work for them.
