Maximising Income at the Expense of Growth

One of the biggest mistakes I’ve made as an investor is trying to maximise income and not paying much attention to growth. The lure of yield is hard to overcome and I’ve succumbed to it all too often.

My own mistakes have been to maximise income at the expense of growth but I’ve not done terribly. And by my count, my networth is more than we’ve actually ever earned – so I can’t claim to have blown away everything – but I certainly could have backed a few more winners over the years. Long term growth beats dividends in the long run but focusing on yield is an easy mistake to make today – after all, when you look at the stock prices in the paper (that’s how old I am) it tells you the price, high/low, change and dividend yield. So important is the dividend yield that it’s abbreviated to YLD. Have you focused on maximising income at the expense of growth?

The Yield Shield

If any of you actually read “Your money or your life” and if you haven’t – buy a copy and read it. The book actually is rather conservative on what you should invest in – typically US government bonds (T-Bills) and low risk assets. Fine advice when T-Bills were paying 8% but now the 10 year bond sits at 0.63% – negative in real terms!… The book is maybe a little out of date but the fact is that these days bonds won’t beat inflation. So, we need to get riskier to make some money and with risk comes reward.

10 year US bond yield over the last 54 years

One way is to invest in shares which have a track record of paying a dividend. Put £1,000 into Diageo paying a 4% dividend and you can expect to eat off that dividend forever. That 4% is your SWR right there – buy enough Diageo and you can retire. Going for growth with companies that don’t pay dividends invites the idea of selling shares to pay for your retirement/cost of living and is not appealing to many (including m). So it’s no surprise that the alternative is that you only spend the dividends – buy those high dividend payers and you are set for life! That’s the yield shield in practice. Of course there are three main risks 1) dividends don’t match inflation 2) your investments perform poorly or 3) a Black Swan event comes and suddenly your 80 years of dividend growth are slashed and you’re in real trouble!

The Limits of Growth

My own personal view is that some sectors and companies are fundamentally limited in what they can do as a business and how they can perform. I’ve worked in a few major companies and can tell you that there is a constant push to improve performance (however that’s measured) and increase profits. But since the process is continuous, you can’t say that a company is doing particularly any better this year than 5 years ago. The market capitalisation of the company already assumes that the “cost savings” from the new CEOs pet project or the recent merger or acquisition will bear fruit.

The limits of growth constrain overall performance. Of course the economy creates new wealth and businesses grow and develop them – look at the impact the iPhone has had on the world – but for most companies, profits which lead to dividends are from past successes and not the future.

If the company is in a stable industry, it is generating enough free cash flow to pay dividends then it’s a good investment? Maybe yes, maybe no. The dividends become attractive to investors like pension funds, GFF, the FIREing squad and investors. But as time moves on, competition comes and squeezes margins. Or you make a major f**k up and nearly go bankrupt. Or technology happens and your products are antiquated and die. Or laws or regulations change and you suffer. That’s the risk and your dividend gets cut or your company disappears – and over many years this will happen again and again. A cycle of birth, growth and death continues – unless your company becomes a vampire corporation, always on the look out for a new victim to suck the blood from through a merger/acquisition.

It’s also hard to capture the wealth from growth – since that goes to the creators of the wealth. Bezos beat Buffett if you know what I mean.

Growth above all else!

If you are set on only focusing on growth companies then you might end up investing early with the next Amazon, Google or Tesla. The return on your capital could be phenomenal. However, it’s riskier – not only do you have to get lucky with what you invest in, you also need money in the meantime. There are risks with the yield shield but at least you can eat dividends – growth is another story. And remember that thinking that you are smart for investing in Tesla back in March and how it’s a super growth stock is fine – but the real money is made by Angel Investors or those who put money (and contribute) early on. By the time you’ve heard of the next big thing, someone’s just trying to cash out by having a retail schmuck buy their shares – pump and dump? And unless you know what you are doing, maybe your growth companies need to be bought at the right time and sold at the right time. Getting your Kenny Rogers right isn’t easy but you do need to know when to hold them and when to fold them. Boring old dividend aristocrats have a simple buy and hold philosophy.

The best investing advice I can think of with a beard

GFF’s mistakes

I’ve made mistakes investing – more than I care to share with you. But even when I (thought I) had my shit together and focused on low cost ETF investing (like we should all be doing); I wrote how I was FIRE proofing the portfolio and invested in the FTSE100 index instead of a Global ETF tracker (VWRL). ISF saves about 0.15% in fees and had a higher dividend (4.5% vs. 2%) – in my book it was a good investment and I thought that I needed the income (I do) but it’s been a shit investment between when I wrote the article and now. The FTSE is down massively from corona virus thanks to large but shrinking businesss in the commodities/oil area and VWRL has a lot of th FAANG type stuff. In fact, it’s said that Apple will soon be worth more all of than the FTSE100 – imagine that.

I have got quite a bit of money in what I would call “infrastructure” as well – boring businesses like infrastructure & renewable energy. These have a sort of aim to pay a decent rate of return by sacrificing future growth and the growth to date has not been too bad but obviously compared to today’s winners they are duds.

If you’ve seen my series on VCTs, I’ve put money into growth companies but performance has been mixed and if anything they are less risky than investing in the FTSE.

Guaranteed Growth?

One problem that I see is that it’s hard for you to guarantee growth in any investment. The best way might be to just avoid bonds – bonds have guaranteed no growth if held to maturity. What you pay is what you get back plus some interest. But as someone without bonds in my portfolio am I just unlucky? We’ve seen massive growth in technology stocks like Apple and Google but are they in bubble territory – yes but I said that this time last year too? This has been a decade of tech growth – both in small companies and in the majors. Who’s the next 10 years for? The biggest pharma/medical companies like Pfizer, Roche, GSK and AstraZeneca were seen by many as just cash engines with little future growth – Covid’s changed that – are they the future? Banks were in favour 15 years ago but are dodgy now. Oil/Gas/Commodities are taking a real beating at the moment – is this a good entry point or is it a sunset industry? Who knows and who dares?

Who actually knows? All I know is that I don’t do well out of eithr predicting winners or backing winner. Maybe the ugly ducklings in my portfolio will turn into beautiful swans and maybe the bubble surrounding companies like Tesla will burst (seriously a car company worth more than half the other car companies in the world – you don’t need to be a West Ham fan to call it out).

Summary

I guess that the lesson is to either not make mistakes or learn from someone else’s. In any case, I’m solidering on with my mix of investments like ISAs, LISAs, VCTs, to manage the tax element and low cost ETFs, investment trusts, community co-ops, P2P for investing and hoping that this’ll carry through at the end of the day. My own mistakes have been to maximise income at the expense of growth but when you only need to get rich once, regretting not picking the right lottery numbers or buying Netflix a nickle a share or bitcoin at a quid a pop is not helpful. Worst still is chasing yesterday’s winners.

Thanks, GFF.

5 Comments

  1. “with risk comes reward”: I know people keep saying that but it’s arsy-versy.

    What may be true is ‘if you want reward you will have to take risk’. That’s a plain different thing because it leaves open the possibility that the risk may be properly so called i.e. you may lose money.

    In my experience the only way to make money with genuinely low levels of risk is to attend carefully to tax avoidance and to harvesting government give-aways. Self-employed NICs – bargain! Deferring old-style state pensions – bargain! 40% tax relief on pension contributions – bargain! No Capital Gains Tax on Principal Private Residence – bargain! Moving investments into the ownership of the lower taxed spouse – bargain!

    Anything else is just patting yourself on the back because a gamble you took turned out in hindsight to have flourished. But historically equity investment has done badly for spells of twenty, thirty, even forty years. And you won’t know in advance whether you face such a spell. Your defence against that is presumably diversification. How diversified investments can be is hard to judge in such an interconnected world.

    Liked by 1 person

  2. I love the idea of building a yield shield but don’t want to throw all my eggs into the dividend basket. The recent cancellations/reductions of dividends clearly shows the risk of just following the one strategy.

    Who knows if the asset mix I’ve chosen is the right one? All I know is that if I hadn’t invested, I’d be a lot worse off so in that respect, it’s a successful strategy!

    I’ve got a few ‘duds’ in my portfolio but I’ll only consider them full blown mistakes if I end up selling them at a loss. Right now, they’re just a line in my spreadsheet (even paying out some dividends) so there’s always a chance they’ll turn from ugly red ducklings to beautiful green swans!

    I bought Tesco shares just as Warren Buffett offloaded his. They’re still showing at a slight loss but hey ho, I got paid a dividend last month!

    Liked by 1 person

    1. on the idea of asset mix – I saw somewhere that only a handful of companies in the S&P500 have actually contributed to the massive gains that they have seen there. So, if you didn’t invest early with these FAANGS (and Tesla) you won’t have seen much growth.
      My thinking about investing over the years and dabbling with regular savers, P2P, dividend payers, renewable energy and all that stuff was that returns of 8-10% a year would be great – that’s in line with long term performance and it gives diversification.
      At the moment it’s not looking like a wise move but who knows what the next 10 years will bring? certainly the current valuations of anything tech are just insane – bubble bubble toil and trouble?

      Liked by 1 person

      1. I’ve been a long term holder of Scottish Mortgage which has greatly benefited from the likes of Tesla and Amazon. Sold some recently to rebalance into investments which are looking rather rubbish so hopefully I won’t be regretting that decision!

        Returns of 8-10% a year is what I’m aiming for too and is pretty much what I got since I’ve been tracking my investments between 2014-19. It’ll be interesting what 2020 will end up at.

        Like

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