Saturday 19 October 2013

The 'Income Sandwich' Portfolio

I am always looking for better ways to communicate the basics of the DIY Income Investor approach. My basic paradigm (I've been watching The Big Bang Theory) is the Income Pyramid, which covers most of the basics (i.e. no debt, good cash management, income-oriented investing), although this model perhaps implies too much rigidity in moving between the Pyramid levels.

But for the investment portfolio itself, a simpler image is perhaps the Income Sandwich. Here's how it works...

The basic structure of a traditional (closed) sandwich is two slices of bread and a filling - but clearly (as Pret a Manger has demonstrated) the range of variations is endless. The recipe for the DIY Income Investor Income Sandwich is as follows:
  • For the top slice of bread take some wholemeal high-yield dividend shares
  • For the bottom slice of bread prepare some rye bread high-yield fixed-income securities (such as corporate bonds, preference shares, Permanent Income-Bearing Shares, etc.)
  • Maybe spread a bit of butter on the slices in the form of cash
  • For the filling, add some Exchange Traded Funds, in the flavours of the two slices above

Tasty, eh?

And how has this sandwich gone down? For 2013 so far the sandwich has turned out to be quite tasty, with a total return of 17%. This is satisfying but not particularly outstanding, if you look at the various benchmarks:
  • FTSE 100 up 15%;
  • iShares' dividend-share ETF IUKD up 20%
  • but iShares' corporate bond ETF SLXX is up only 1%

However, the 2013 performance follows on from a bumper 2012, when the portfolio increased by 33% - so this increase in value has been preserved. (This followed a slight loss in 2011 and a slight gain in 2010).

Just as a culinary sandwich needs to have attractive proportions, so the Income Sandwich needs a reasonable balance between the elements: I think that there should be a balance between the two 'flavours' (dividend shares and fixed-income securities) and that the filling should be substantial.

My own Income Sandwich portfolio has become a bit unbalanced over the past year and is currently:
  • 45% dividend shares
  • 23% fixed-income securities
  • 27% ETFs (split fairly evenly between the two flavours above)
  • 5% cash

So, it looks like a bit of re-balancing of flavours in the Income Sandwich recipe (in favour of fixed-income) might be required. This is problematic, given the generally-expected coming crash in bond values. One option is dated bonds with a fixed redemption date (such as my recent purchase of Yorkshire Building Society debt); at least you know what you are getting, as opposed to many PIBS, which have potentially unattractive 'follow-on' yields if they are not actually 'called' at maturity.

What's your recipe for income?

I am not a financial adviser 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.

1 comment:

  1. King of Cornwall20 October 2013 at 16:46

    - 40% dividend shares
    - 20% growth shares
    - 19% ETFs
    - 8.7% Inflation Linked bonds (mainly NSI)
    - 3.8% Fixed Income bonds
    - 2.3% Investment Trusts
    - 2.7% Cash
    - 2.2% Zopa
    - 1.3% OIECs
    The income from the growth shares is taken by taking profits for 2 times the CGT limit each year. Despite this, the growth share proportion of the portfolio is increasing much faster than the rest.