Lower share prices are good for the IFL portfolio
Lower share prices are good for the IFL portfolio. This is my third instalment of my new Income For Life (IFL) portfolio, launched as a successor to the highly successful Rising Income Retirement Portfolio (RIRP), now in its eighth year.
The good news is the markets have fallen since I launched the IFL portfolio in April; the shares I bought then are now worth on average some 7% less than I paid for them.
I am particularly pleased that the average share price fall since April is almost exactly 7.5%, since arithmetical magic means that as I invest the rest of the portfolio it will yield some 8% more than originally envisaged last April, so largely offsetting the Osborne “We now really are in it together” 7.5% hike in dividend tax which comes into effect next April.
The bad news is I had set myself a very high target for IFL’s first-year yield – “as close as possible to 4% net of basic rate tax”. The first year is always the most difficult when building a portfolio from scratch because of the gap between companies’ ex-dividend dates and actually receiving the first payouts.
I wanted to try and replicate the benefits from pound cost averaging which worked so well for the precursor of this portfolio, the Rising Income Retirement Portfolio.
Struggling to gain cost averaging benefits
But the RIRP took 7 years to get fully invested, and the 12-month time limit for the construction of the IFL portfolio is frankly not long enough to reap the full benefits; pound cost averaging only really comes right over a full market cycle. Although the market is usefully lower now than it was when I started, in the short term I have sacrificed first year income for only slightly higher long-term higher yields.
As an example, one of my biggest fallers is Centrica, in which I had invested £4,000 of my guideline £5,000 maximum by last July at an average price of 267p with a yield of 4.4%. Now they are down to 225p, giving new investors a yield of over 5.3%.
But in topping them up to the maximum £5,000, this only has the effect of raising the average yield on the total investment from 4.4% to 4.7%, and because the ex-dividend date falls a couple of days before our publishing date, in the current year I lose £53 of income which I could have otherwise booked in the first accounting year to end March. It will take a long time for the higher yield on the latest purchase to make up that £53 deficit.
IFL will hit 5% yield target
But we are where we are, and I embark on this latest set of purchases with the portfolio from July (already just over half invested) projected to exceed the full year yield target of 5%.
My strategy this time is to maximise income for the remainder of the accounting year to end March by topping up to the maximum those shares going xd between now and December, and choosing 6 new shares to bring the total portfolio up to its full strength of 20 shares, most of them paying out more than half their annual dividends between now and March.
So I am investing the bulk of the remaining funds now and am topping up every share by at least a single thousand pound unit. To capture any possible future benefit from pound cost averaging, where shares are not going xd in the coming quarter I am making only a minimum £1,000 top-up now. This leaves £12,000 available in January from the notional £100,000 available to top up the remaining shares in which we have not yet invested the maximum £5,000.
New buys have lower yields
Apart from bank note printers De La Rue, my new additions Marston’s, Sky and Real Estate Investment Trusts Hansteen and Tritax all yield a little less than the initial selections, where I naturally went for the higher-yielding low hanging fruit. I have resisted the temptation to compensate by going for BHP Billiton whose dividend for the coming half-year alone comes to 4%, but in researching yield-boosting alternatives I have discovered Utilico Investments, currently standing at a 25% discount to net asset value as it shifts its investment priorities from utilities and infrastructure to technology. I shall now add this to my own portfolio, as hitherto all the shares for both the RIRP and IFL are selections from those I own, and this should be no exception.
Before this issue’s changes, my projected income to end December came to a little over £1,100 representing a respectable return on the sums invested by July of over 2.2%. After this issue’s new purchases, and top ups, shown in the final column of Table 1, the end December cash projection rises by nearly 50% to nearly £1,600, but as a percentage of the sums invested it falls to under 2%.
That still gives an annualised return of over 2.4%, equivalent under this year’s dividend taxation rules to 3% pre-tax from a bank, which is more than most subscribers are likely to be getting even on maturing long term funds. The full-year projection of yield from the portfolio after these purchases is 5.3%.
Since the IFL’s investment mandate for January, outlined above, is straightforward, I shall devote that month’s article to reviewing the 8th year of the original portfolio, the RIRP. As Table 2 shows, this has quietly continued to deliver dividend increases of over 6% so far this year with absolutely no management from me, in addition to special dividends equivalent to a further 2.7% of the fund’s value.
As I have done with the RIRP, I reserve the right to tinker with some of the initial IFL share selections next year when I may jettison some of the initial income-boosters in favour of those with better prospects for dividend growth, but I am already confident that the IFL will deliver similar inflation- beating dividend growth from an even higher first full year yield than I had expected last April.
First published in The IRS Report on 3rd October 2015.