Friday 20 May 2011

Portfolio Rejuvenation Through Income Investment

One of the benefits of running an income-based portfolio as promoted in the DIY Income Investor approach is that it requires regular re-investment. This comes about because of the cash interest, share dividends and bond coupons, as well as new money for investment coming up through the levels of the Income Pyramid. I reckon these 'refreshing' new purchases amount to 15-20% of our investment portfolio each year.

This flow of cash requiring allocation means that a long-term plan is required, with practical investment rules to help to answer the question - now what?

This regular decision-making on new investment (or saving, for that matter) allows a continual refinement and rejuvenation of the whole income portfolio - allowing yield to be improved as well as diversifying holdings. For example, it is possible to add 'new blood' to a High Yield Portfolio by buying a new company to provide greater sector diversification .

The framework of the DIY Income Investor approach provides the basis for a decision on what to do with spare cash. So, assuming the cash savings levels of the Income Pyramid are OK, the decision will come down to:
  • high-yield shares (Level 6)
  • government bonds/gilts (Level 5)
  • corporate bonds (Level 7)
  • or, of course, ETFs including the above asset classes (Level 4)

To invest in 'non-perpetual' corporate bonds requires (usually) larger lump sums - so decisions on those can wait for an annual top-up of the tax-exempt account (in the UK ISAs). Perpetual bonds, Government bonds, shares and ETFs can be added with a smaller outlay.

The amount to reinvest will depend on your own situation - the aim is keeps dealing costs down (and therefore avoid small purchases) but also not to keep cash sitting in an investment account (and therefore not working hard earning you income). I usually invest in bundles of around £3k, which works psychologically for me - large enough to be significant but not large enough to cause a hiccup in the overall investement process.

Overall we are aiming at high yield with a low level of risk. Current yields available are:
  • government bond (perpetual): 4.9%
  • corporate bond (perpetual): 6.9%+ (including HSBC, Barclay, Abbey National, Standard Chartered)
  • high-yield shares: 6%+: Todd Wenning (of the Motley Fool) has recently identified some out-of-favour high-yield shares
  • ETFs: 4.4% (corporate bonds - non-financial); 4.5% (HYP)
I'm tempted by the perpetual corporate bonds - this would 'lock in' a high yield but would be a gamble on the stability of the financial system. The choice of investment is also limited sometimes by the range of investments offered by the account itself.

What do you think?

I am not a financial advisor and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.

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