Is the search for higher income yield misguided?

180423.Leaky bucket

Income yields are down, but should you worry?

The last few years have seen a fairly dramatic drop in the income yields obtained from typical balanced (i.e. roughly equal defensive and growth investments) investment portfolios. Reduced interest rates, lower rental yields on property and flat to declining dividend yields on shares mean that many retirees are no longer able to meet living expenses solely from the cash distributions (i.e. the income yield) generated by their portfolios.

There is often a reluctance to sell investments (i.e. draw down capital) to maintain desired spending. Rather, the apparent solution to the shortfall is often seen as higher yielding investments (e.g. higher risk fixed interest securities, including hybrids, high dividend paying shares and other structured products), with there being no shortage of financial product manufacturers happy to respond. However, yield enhancement always comes at the expense of a combination of increased credit risk, reduced diversification and/or increased taxation.

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The trade-offs for financial independence

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There are three levers of financial independence

To increase the chances of achieving financial independence (i.e. having sufficient investment wealth to fund your desired lifestyle indefinitely, without the need to work), you have essentially three options or levers available to you. They are listed below in order of capacity to directly control:

  1. Reduce cash outflows, including lifestyle spending, taxes and investment costs;
  2. Increase cash inflows, primarily from increased employment or business income; and/or
  3. Increase net (i.e. after costs) investment returns.

Most families have significant discretion regarding the amount of their cash outflows and, within a fairly broad range, are able to decide (above a base level of living) how much they want to spend.

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Diversification v Concentration: A tortoise and hare story

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Concentrate your investments to make and lose a lot of money

The following recent Twitter exchange was the catalyst for this article:

The initial tweet above is a quote from Jim Rogers, a well known US investment commentator, who believes he can reliably pick investment winners and time investment markets, despite robust academic research suggesting such skills are both incredibly rare and difficult to identify. However, his view that if you want to make a lot of money you should avoid diversification (i.e. spreading your investments as broadly as you cost effectively can) is undoubtedly correct.

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Confessions of a frustrated financial planner

Confessions of a frustrated financial planner
Responding to what I consider “dumb” money decisions

The recent Christmas/New Year period again provided time to meet less regularly seen family, friends and acquaintances and catch-up on what they have been doing. Inevitably, given what I do, the subject of personal finance often arose in some shape or form.

And it’s not usually raised by me. Invariably, the initiator is looking for my endorsement of whatever financial action/decision they have already taken or are committed to taking. They really aren’t particularly interested in hearing the almost inevitable reservations I may have.

Sheltering behind my ongoing obligation to “know the client”, I avoid getting involved in what experience has told me is likely to be a frustrating and fruitless conversation by simply saying I don’t have enough information to provide a worthwhile opinion.

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“wealthcheck” for mid-career professionals

“wealthcheck” reveals where you are on the path to your financial independence

wealthcheck for mid career professionalsIn previous articles, “ ‘wealthcheck’ and retirement preparedness” and “ ‘wealthcheck’ for early career professionals”, we applied the “wealthcheck” framework to examine and compare the financial soundness of couples at both the early and late, pre-retirement, stages of their professional careers.

In this article, we look at two “typical” mid-career professionals to again demonstrate the effectiveness of “wealthcheck” to highlight key sources of financial vulnerability. The article also highlights the reality that you can’t assess your progress on the path to financial independence by observing the financial and lifestyle behaviours of those you consider are a lot like you.

Again, two fictitious couples are illustrated, the Pinks and Greys. Both are 17 years away from a projected retirement and approaching their peak earnings years. Children are either in or soon to be in their teens, with lifestyle spending peaking due primarily to the cost of private schooling.

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Is there a “house price bubble” when over 50’s are borrowing to buy investment property?

Few residential property “experts” think there is a “house price bubble”

Is there a house price bubble when over 50s are borrowing to buy investment property?We have previously discussed what we consider to be the significant risks associated with increasing numbers of baby boomers borrowing to invest in growth assets, particularly residential investment properties. But it is apparent that the major risks that concern us are not even on the radar of some of the residential property “experts”.

A recent Blog article titled “Australia’s So-Called ‘House Price Bubble'” by John Edwards, founder of residential property researcher, Residex, supports this view. In the article, Edwards explains that while the ratio of median Sydney house prices to median income is 8 times – “extraordinarily high based on historical data” – this is not indicative of a “housing bubble”.

Why? Because the buyers of residential property “are no longer median income families”. He asserts that “buyers of house and land are now second and third time housing buyers, with income levels which are much higher than the median income wage”.

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How much investment risk can you bear?

How much investment risk can you bear?
Your allocation to growth assets is a key measure of investment risk

In our previous article in our series on the Personal Financial Dashboard – a graphic format that succinctly captures the journey to, arrival at and maintenance of financial independence – we discussed the need to be tax aware when investing. Financial independence is harder to achieve if there is an unnecessarily large tax leakage.

But tax shouldn’t be the overriding factor when making investment decisions. Rather, the primary focus should be on risk and related return. The Personal Financial Dashboard includes two charts which look at key aspects of investment risk management i.e.:

  1.  the Growth  Asset Allocation Ratio (Chart 5); and
  2. the Diversification Ratio (Chart 6).

In this article we focus on the Growth Asset Allocation Ratio (“GAAR”). The Diversification Ratio is discussed in our next article.

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Should your feelings influence investment decisions?

Should your feelings influence investment decisions?Our feelings aren’t reliable indicators of future investment returns

If you let it, investing can be an emotional roller coaster. But while in many walks of life how we feel may be an important input to decision making, letting short term emotions substitute for a soundly constructed long term investment strategy is generally not a good idea.

For example, the emotions of fear and greed, allowed to run unchecked, can drive behaviours that are deleterious to our financial health. Evidence shows we often rush to sell when share (and property) markets are at their gloomiest (with prices relatively low) and fall over ourselves to buy when asset prices have risen and are relatively high. Consistently selling low and buying high is a sure fire way to go broke.

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Has the investment world changed?

Has the investment world changed?
Will shares continue to outperform cash?

We use the chart below, showing a comparison of the growth since 1926 of a $1 invested in the US share market  with a $1 invested in cash, to reveal a couple of key historical insights about investing, including:

– There was a huge opportunity cost to investors of “playing it safe”, by holding all their investment wealth in cash; and

– The returns to shares were anything but smooth with the market often taking many years to recover its previous highs after a major downturn e.g. the US share market is still a long way from recovering its peak of March 2000.
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Should Gen X ever desert the share market?

Should Gen X ever desert the share market?Gen Xers should be rejoicing

An article in “The New York Times” of 29 May 2012 titled “Younger Investors Jaded About the Stock Market, Survey Finds”, reported that a survey commissioned by Charles Schwab & Company revealed:

“About a third of Americans aged 18-34 said they planned to pull money out of the stock market and were most likely to “sit on the sidelines” in the next six months”.

The gist of the article was that young adults had been scarred by the stock market performance of the past 4-5 years and, accordingly, were reluctant to take investment risk. We would expect to find that Australian Gen Xers have a similar attitude.

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