When ‘Success’ and an Income Portfolio don’t mix

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I’ve been meaning to write this hopefully fairly short Blog for a while but I keep getting distracted onto other things and we actually discussed this on a recent TPI Podcast so I wasn’t feeling a huge need to get it written. Having said that, we didn’t go into a comprehensive coverage of the issues and there is always a sense I have that I should try to cover as many topics as I can within my Blog Archive, so that WD Readers can revisit it in the future if they want to know about something. Maybe new Readers might find it useful also as the whole WD thing should really be to help Newbies as its main Sultana d’Etre (should that be ‘Raisin’?).
 
The essence of the ‘problem’ with my Income Portfolio is that my original theory behind it was to generate an Income Stream from the Dividends that was at least 5% a year based on the starting position each year. Apart from other aspects such as low activity and low risk and the diversification benefits, part of my thinking was that at some point in time in the future, I might have grown the Income Portfolio enough so that it would be throwing off Dividends that might amount to maybe £6,000 a year or so and that with other Income sources I have, I could get to a position where my Yearly Spending needs on food and rent and stuff are covered without me having to sell any Shares or make any money on Spreadbets etc. It is simply easier to just take Dividend Cash out of an Account than to have to think about which Shares to sell and all the timing issues and suchlike.

I am having no big issues with finding enough Cash for my Living requirements and therefore my approach in recent years has been to re-invest the Dividends received in my Income Portfolio and to focus on building the Pot up so that it gets to a size where it can generate a nice Income Stream just from the Dividends. At the time of writing this my Income Portfolio is probably worth around £55,000 and if this was to throw off 5% of Dividends, that would be £2750 a year so my target of £6000 is some years off as I keep growing the Account and I really need to get to £120,000 to achieve £6000 at 5% payout (the Shares all sit in an ISA so there is no Tax to worry about).
 
I therefore need to more than double my Account to hit £120,000 which will take many more years of re-investment (especially if the Capital Value suffers too much from this flippin’ Virus issue) but I could transfer Money from other Share Accounts etc. into this Portfolio which I might end up doing. I am not feeling a desperate need to create this Cash Generator but I am 55 years young now and the rough age I had in mind was 60 to be at my Target of £120,000; it looks like that will be difficult unless I add some Funds in the next few years.
 
Trouble is I am over-simplifying things, which is something that often seems to happen with this Investing game where what appears a pretty rock-solid case in theory, doesn’t quite play out as you would like in the practicalities of ‘The Real World.’
 
The catch is that if you look at my ‘Scores on the Doors’ Blog for 2019 (go to the ‘Category’ ‘Scores on the Doors’ on the ‘Educational Blogs’ page) then you can probably see that the actual % Return of Dividends on my Income Portfolio for 2019 was 4.8%, so even that did not reach my 5% Target Dividend Stream. But the problem is actually worse than that. If you read on further you should see that the Dividends Received over 2019 would be just 4% when expressed against the starting Valuation for 2020 - so a long way off my Target. There might be a small mitigation here if the Dividends that my Stocks pay out in 2020 rise a bit against 2019 – but it would only at best increase it to maybe 4.2%.
 
This problem has arisen because some of my Stocks like AstraZeneca AZN and Primary Health Properties PHP have done really well in terms of their Share Prices over 2019 and as a result the Dividend Yields in percentage terms that they throw off has fallen a lot. As an example, at the time of typing this on the evening of Thursday 27th February 2020, the Forecast Dividend Yield on AZN is 3.1% and on PHP it is 4% (note both of these Stocks are expected to have higher Yields 2 years out of 3.2% and 4.1% so they are hopefully going in the right direction but both are clearly some way off my 5% target).
 
But the clear point is that as the Share Price rises the % Dividend Yield you get as a Return drops – so the drawback of ‘success’ in terms of a strongly rising Share Price is that the overall Dividend Yield of the Portfolio reduces in percentage terms (although it might actually increase in Pound Note terms).
 
The question is, what to do about it?
 
To be honest, at the stage I am at where I am not desperate for a 5% Payout for my Living needs, the fact that the Portfolio Yield could be down to 4% is not something I am panicking about too much but if I was in a position where I needed the Money, then perhaps I would have to adjust my Portfolio by selling some Stocks and buying others.
 
Let’s assume I am in the situation where I need a 5% Payout to enable me to eat. We could even add more colour by saying that my Income Portfolio Account could be worth £120,000 and I am expecting £6000 to flow out of it but because the Dividend Yield Percentage is down to 4%, I would ‘only’ be getting £4800 and that would not be enough. If this was the case, then I am assuming that I would need to sell some of my very successful Positions like AZN and PHP because the Dividend Yields on them had dropped so much, and I would need to divert the Cash freed up from those into more of Stocks I already hold where the Dividend Yield is 5% or more or perhaps I would need to introduce new Stocks with higher Yields into the Portfolio. Of course, the problem with doing this is that I would probably be selling my successful ‘Winners’ which have momentum and are pushing higher, in favour of some Stocks that might be displaying Price Action more associated with ‘Losers’. It is a bit of a conundrum.
 
Because I am not in ‘Drawdown’ mode with regards to this Income Portfolio, I am relaxed about letting two excellent Stocks like PHP and AZN run as they are and I accept that the downside is a Dividend Yield that is lower than what I would consider as ‘ideal’. However, at the time of typing this we are in the full throes of a nasty Market sell-off due to the Virus and if this continues in coming weeks and months (as I suspect it could easily do), then these Stocks may drop back and as a result get much higher Dividend Yields again. If this happens and I have Cash around to get buying with, then at some point I might be able to buy into some nice Dividend Streams with good Yields.
 
There is certainly an argument that I will be better off ultimately if I stick with my ‘Winners’ and accept that lower Yields will be the result, rather than cutting the legs off what could be my ‘best’ Stocks and moving the Cash freed up into buying more of the Shares that I hold which are more sluggish and not really delivering the Capital gains although they might have more generous Dividends. There truly is no easy answer although because I am really more focused on growing the overall value of the Pot, I am probably happier to stick with my Winners.
 
If I was in a Drawdown situation where I did need to pick up the Cash Dividends and take them out of the Account for spending in The White Hart, then it might be worth creating some Rules to help make things more process driven and to take out some of the emotional angst. For example, a Rule could be that once a Stock grows so much that the Forecast Dividend Yield falls to below 2.5%, then I should automatically sell the Stock and reinvest the Money into a Stock I already hold or into a new Stock (my 2.5% figure there was very arbitrary and in practice I would need to think long and hard about this and perhaps it should be 3% or something).
 
Anyway, from writing this it has helped me decide my approach going forwards and I am keen to stick with great Stocks like AZN and PHP because I know them both very well and often there is a lot to be said for holding things you understand to a fairly complete level. After many years of holding AZN I feel pretty confident to continue to keep it and I have had PHP a while now and been very impressed in the time I have held it; and if anything I would love it if the price was to continue to drop back and therefore enable me to buy more of it with a nice chunky Dividend Yield.
 
Oh, if only more of my ‘problems’ were of such a high-class nature !!
 
Regards, WD.
 
 
Related Blogs
Here is that ‘Scores on the Doors 2019’ Blog I was on about earlier:
 
https://wheeliedealer.weebly.com/educational-blogs/scores-on-the-doors-2019
 
And here is a Stock Buy Rationale I wrote about PHP, which seems a bit appropriate (there is a link to Part 1 at the start):
 
https://wheeliedealer.weebly.com/educational-blogs/primary-health-properties-php-buy-rationale-part-2-of-2