My Principles for Income Investing

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AlpineTR
Posts: 21
Joined: Wed Mar 22, 2023 7:53 pm

My Principles for Income Investing

Post by AlpineTR »

I’m new to this forum, so I thought I’d share a few of my investing principles. I was hesitant to do this for all the standard reasons, namely the risk that someone interprets this as advice, which it is not. You must DYODD and find the portfolio that fits your own unique skills, abilities, needs, wants, tax status, etc.

Principle 1 - I like income (obviously)
For my own psychological makeup, I am far more comfortable relying on dividends, interest, rents, royalties, option income, etc. than I am relying on capital gains alone. I am willing to give up future capital appreciation in exchange for current income. I accept this trade off even though I understand intellectually that the way to end up with the most wealth over a long period of time is to invest in companies with the ability to reinvest their retained earnings at incrementally higher rates of return. I accept this trade-off because those companies with long runways for reinvestment are very, very hard to identify, and even if you can identify them, the market might decide they are worth less than you paid for them for a long period of time. In turn, I accept that the next best thing is to find companies that return cash to shareholders if they can’t find acceptable places to reinvest all of their earnings. Ideally, I can find companies that do so in such a way that their cash returns to shareholders will increase with (or outpace) inflation. I'll mention that I share my affinity for income with Dr. Jeremy Siegel, who coined the term "Bear Market Protector" and "Return Accelerator", which is based on research showing how reinvesting dividends in falling stocks of fundamentally good businesses ultimately lead to lower breakeven points and outsized returns when they recovered. Even if you're not reinvesting dividends, the same idea holds for those living off the income from these dividend stocks.

Principle 2 - I am flexible and risk-averse
In the Intelligent Investor, Ben Graham, encourages you to evaluate your investments among all possible alternatives. You can't make a decision to buy a stock trading for 15x and paying a 3% yield in isolation (e.g. what if the alternative is treasury bonds yielding 10%?). In addition, Graham encourages, general risk thresholds. For me, this means I won’t exceed a certain percentage threshold of equities (Graham suggests 75% as the max), I won’t let one position exceed 10%, etc.

Principle 3 - Beware bloggers bearing dogma
In general, I dislike the dogma around index funds and total return investing. Yes, it’s worked in the past and yes, I think it will likely continue to work in the future, but people forget that index funds are just tools, not miracle machines. You can use index funds, individual securities, or both. That’s the beauty of life - you get to make your own decisions. I can (and will) do what suits my situation best.

If you use index funds, you should know some of the disadvantages beyond just the expense ratio (e.g., what are the tax consequences of a run on the fund?). If you’re investing in index funds, you should download the holdings in excel and calculate how much money you have in each underlying component. If you own $VTI, ask yourself if you’re comfortable, for every $100 you invest in the fund, investing $1 into an unprofitable car company led by a modern day Robert Maxwell that is trading at 7x sales. If you own, $BND, ask yourself why you’re comfortable accepting a 2.6% yield with a duration of 6.5 when you can buy similarly-dated T-bills yielding more than 4%. There’s no wrong answer here per se, but you should know what you own!

You could build any number of portfolios based on these principles. A hypothetical portfolio might look like the following. This is not what I hold, but just an example:

20% Individual dividend stocks of your choosing, if that's your thing.
20% A dividend index fund, say $VYM, containing securities that represent America, Inc. - essentially a toll gate on all economic activity - that will likely appreciate slowly as they throw off ever-increasing amounts of cash.
20% A broad market index fund - if you are still working and you believe you need capital appreciation.
20% Real estate REITs, funds, or outright holdings structured and financed appropriately
20% Bonds and cash yielding today's rate of almost 5%

Alternatively, you could simply choose some balance between $VYM and individual bonds, say 50/50.

Either way, for every $1m in this portfolio, it’s conceivable that you could receive $3k in income per month, in perpetuity, deposited directly into your checking account, without ever touching your principal, or spending more than an hour or two per quarter re-allocating capital. If you're still working, great. You can reinvest, spend, or give that money away to charity until you decide to retire.

I like Jacob’s suggestion elsewhere on this forum that one should set this up before ER to get comfortable with the mechanics of the cash flows. For example, I have my brokerage account automatically transfer all dividends and interest directly to my checking account for me to then decide how re-allocate. Once you have all your job income going into savings, you're officially ER.

I’m new to this blog, but I believe this is similar to what Jacob refers to when he talks about his SWAN portfolio. Either way, it works for me and I thought it’d be helpful to share. Jacob, my apologies if I'm mischaracterizing what you've said.

sky
Posts: 1726
Joined: Tue Jan 04, 2011 2:20 am

Re: My Principles for Income Investing

Post by sky »

Thank you for laying out this strategy.

How does the approach change in a high inflation environment?

Henry
Posts: 499
Joined: Sat Dec 10, 2022 1:32 pm

Re: My Principles for Income Investing

Post by Henry »

AlpineTR wrote:
Mon May 29, 2023 3:14 pm
I won’t let one position exceed 10%, etc.
I vehemently object. To me, this is like saying I'm only staying married for the honeymoon.

AAPL is 40% of BRK.

AlpineTR
Posts: 21
Joined: Wed Mar 22, 2023 7:53 pm

Re: My Principles for Income Investing

Post by AlpineTR »

Henry wrote:
Tue May 30, 2023 7:19 am
I vehemently object. To me, this is like saying I'm only staying married for the honeymoon.

AAPL is 40% of BRK.
That's also the beauty of life - you set your own rules!

And I'm not saying I always follow my own rules. :D I'm currently selling down a position that grew to be more than 20%. It's probably fine, but it was inconsistent with my ability to SWAN.

AlpineTR
Posts: 21
Joined: Wed Mar 22, 2023 7:53 pm

Re: My Principles for Income Investing

Post by AlpineTR »

sky wrote:
Tue May 30, 2023 7:01 am
Thank you for laying out this strategy.

How does the approach change in a high inflation environment?
People look at inflation lots of different ways. If you own your house, your property taxes are capped, and you're growing most of your own food, then you might not even need to grow with inflation. In that case, you might prefer higher current distributions along with minimal growth. I tend to look for companies that are growing their dividend by approximately the same rate as inflation. For example, take a look at the historical distributions of $VYM. On a trailing 12-month basis, the distributions have almost doubled over the last 10 years, which is an average of 7% per year. That's a better real return when inflation was low, but at least it's keeping pace in an inflationary environment.

Henry
Posts: 499
Joined: Sat Dec 10, 2022 1:32 pm

Re: My Principles for Income Investing

Post by Henry »

I think every investor has a few "grandma's mumu" picks in their portfolio - one or two picks that hide all the ugly shit no one wants to look at. Buffet had Geico and then AAPL to cover up Kraft Heinz. Wood has Tesla to cover a lot of speculative stocks. NVDA just rose to 1 trillion. Like anybody saw that coming 10 years ago.
Last edited by Henry on Tue May 30, 2023 12:10 pm, edited 1 time in total.

tylerrr
Posts: 679
Joined: Tue Dec 13, 2011 3:32 am
Location: Boston

Re: My Principles for Income Investing

Post by tylerrr »

VYM is good, but I love SCHD to fit into your strategy....along with some BTC/ETH. :)

frugaldoc
Posts: 85
Joined: Fri Jun 30, 2023 1:31 am
Location: Sasebo, Japan

Re: My Principles for Income Investing

Post by frugaldoc »

Henry wrote:
Tue May 30, 2023 7:19 am
I vehemently object. To me, this is like saying I'm only staying married for the honeymoon.

AAPL is 40% of BRK.
I was at the the BRK annual meeting this year and someone made a similar claim about AAPL's percentage of the Berkshire portfolio and Buffett quickly corrected them. AAPL may be 35% of BRK's publicly traded equity portfolio but BRK has many businesses it owns outright (e.g. BNSF) so Apple's percentage of the Berkshire portfolio is not close to 40%. When you attend the annual meeting you are often amazed at the sheer number of companies BRK owns.

Henry
Posts: 499
Joined: Sat Dec 10, 2022 1:32 pm

Re: My Principles for Income Investing

Post by Henry »

frugaldoc wrote:
Sun Jul 23, 2023 6:14 am
I was at the the BRK annual meeting this year and someone made a similar claim about AAPL's percentage of the Berkshire portfolio and Buffett quickly corrected them. AAPL may be 35% of BRK's publicly traded equity portfolio but BRK has many businesses it owns outright (e.g. BNSF) so Apple's percentage of the Berkshire portfolio is not close to 40%. When you attend the annual meeting you are often amazed at the sheer number of companies BRK owns.
I stand corrected and thank God I wasn't the guy to get shot down by Warren Buffet in front of thousands of people. That being said, 35% is still a significant percentage.

PhoneticNachos
Posts: 43
Joined: Thu Jan 26, 2023 9:17 pm
Location: Jacksonville, FL

Re: My Principles for Income Investing

Post by PhoneticNachos »

I bet you would like the book 'The Income Factory' by Steven Bavaria.

CS
Posts: 709
Joined: Sat Dec 29, 2012 10:24 pm

Re: My Principles for Income Investing

Post by CS »

Reading the Permanent Portfolio might bring you some interesting information for allocations if you are risk adverse. https://www.amazon.com/Permanent-Portfo ... B0097VBOHG

At the very least it covers deflationary periods, and high interest periods, both of which most of us are not first-hand experienced in.

AlpineTR
Posts: 21
Joined: Wed Mar 22, 2023 7:53 pm

Re: My Principles for Income Investing

Post by AlpineTR »

CS wrote:
Wed Aug 30, 2023 6:18 pm
Reading the Permanent Portfolio might bring you some interesting information for allocations if you are risk adverse. https://www.amazon.com/Permanent-Portfo ... B0097VBOHG

At the very least it covers deflationary periods, and high interest periods, both of which most of us are not first-hand experienced in.
Thank you. I found reading their annual report extremely interesting. It's fascinating to see which securities they selected to implement this portfolio:
https://www.permanentportfoliofunds.com ... 230131.pdf

AlpineTR
Posts: 21
Joined: Wed Mar 22, 2023 7:53 pm

Re: My Principles for Income Investing

Post by AlpineTR »

PhoneticNachos wrote:
Wed Aug 30, 2023 3:44 pm
I bet you would like the book 'The Income Factory' by Steven Bavaria.
Thank you! Looks good. I will read it.

xmj
Posts: 120
Joined: Tue Apr 14, 2020 6:26 am

Re: My Principles for Income Investing

Post by xmj »

One of the best books on the Permanent Portfolio that I've come across so far was

Investing Equanimity: The Logic & Wisdom of The Permanent Portfolio by Eric Deslauriers. Published in 2020, it was written by one of the members of the OG PP forum GyroscopicInvesting (see the launch thread here).

It explains the theoretical basis of the four components and how they interplay during the various times of economic expansion/decline, then explains the process and mechanism of a four-fund rebalanced polio (including a chapter about PP relevance for FIRE), and concludes with 17 parables.

If you're looking for a friendly exploration of the permanent portfolio and its benefits, look no further.

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