Tuesday, 23 June 2009

Generating Cash: Income from Securities with the High-Yield Couch Portfolio

The last post outlined two basic approaches to generating cash to spend from investments: A) buy the type of securities that produce a lot of cash or, B) take whatever cash is needed from rebalancing an asset allocation portfolio. The next two posts take a look at examples, conveniently provided by the famous Couch Potato portfolios as shown on the Canadian Moneysaver website. The cash income version is the High-Yield Couch Potato and the asset allocation version is the Global Couch Potato.

Hypothetical Scenario:
  • $240,000 starting amount invested in a non-registered taxable account
  • $13,000 annual cash to spend as retirement income must be generated
  • fictitious one year market price changes - Global rises to $258,000; arbitrarily chosen to demonstrate how the asset allocation method would work
  • recent actual cash yields of the various ETFs to bring out the differences between the two methods.
Today's post reviews the ...

High-Yield Couch Potato
This minimalist collection of four securities, all ETFs, consists of:
  • a Canadian dividend fund (TSX: XDV)
  • a US dividend fund (NYSE: VYM),
  • a Canadian income trust fund (TSX: XTR) and
  • a Canadian bond fund (TSX: XBB),
The Couch High-Yield is assembled for yield and it certainly delivers. Yields are so high at the moment, the cash objective would be more than met - $15,300 in annual dividends and interest. It is hard to predict exactly how much cash will be received with dividends as companies raise or lower them according to their business success. Thus, in different years the expected cash yield may be above or below the target. The table below shows the portfolio contents and hypothetical cash flows, including taxes.

Riskiness - The big question - will the yields be sustained? Note the Income Trust holding XTR, which has a very high yield of over 12%. The recession and lower oil prices are causing many Income Trusts to cut distributions. Yields are relatively high because prices have fallen so much. The next chart from Google Finance shows how much of a drop there has been for three of the four securities - XDV, XTR and VYM have declined anywhere from 26 to 42% since 2006. That wouldn't be very comforting to the investor who started out in 2006.

Taxes - High-Yield does ok but not great on taxes with a weighted average tax rate of 25% due to the 70% of cash that comes from highest taxed interest / ordinary income, which includes all the US dividends since they do not benefit from the preferential lower rate on Canadian dividends.

Time and Effort to Maintain - initial set up would be dead easy, taking a few minutes to buy equal amounts of four ETFs with really no on-going maintenance to do. Cash would come automatically into the account four times a year based on the distribution frequency of these ETFs.

Inflation - three of the funds are equities and should be able to adjust for inflation by raising distributions / dividends. The bond fund XBB is not inflation-indexed and would suffer.

The next post covers the Global Portfolio and compares it with the High-Yield.

1 comment:

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