Investment Workshop 14: Withdrawing From Your Portfolio 2

So after the enthusiastic reaction to our last post about withdrawing from our portfolio, I thought I might tackle a few of the follow-up questions we got from that, both from comments and over email.

How does your Yield change as the stock market fluctuates?

Generally, when you make a purchase your yield, as a dollar amount, becomes fixed. For example, if you buy a bond or a preferred share yielding $5 a unit, and your purchase price per unit is $100, you are going to be getting a 5% yield on that asset.

But let’s say that the price of that asset, for whatever reason, swings up or down. Let’s say the price plummets from $100 all the way down to $50. What is your income? Still $5 per unit.

Your yield is determined by your buy point. Any subsequent price fluctuations don’t change the fact that you’re still making $5 a year off every $100 unit your purchased.

What about Inflation? Does your Yield increase to match your increased cost-of-living?

Not on its own.

As we described above, yields are locked in when you buy and generally don’t change with price fluctuations or inflation. There are some exceptions of course, like Real Return Bonds (or TIPS as the Americans call them) which adjust their yield with inflation, but we don’t own any ourselves.

So how do we deal with inflation? Our inflation hedging strategy goes like this:

  1. Keep a significant equity weighting. Under normal inflationary periods, equities serve as an inflation hedge. This is because as prices rise, companies get to charge more for their products, which in turn means higher profits, which in turn means higher stock prices. We plan to keep an equity weighting of 60% for now, possibly increasing into the future.
  2. Re-balance. If we just leave the fixed income part alone, the yield won’t keep pace with inflation. So it’s important that as our equity portion increases, we harvest some gains and buy more fixed income. This will increase our yield because there is now more money generating income.
  3. Use global arbitrage to control inflation. Inflation is always measured per-country. How much of that country’s currency is needed to buy a basket of that country’s goods. But what people forget is that just because your portfolio is in one country doesn’t mean you have to live there. Japan’s been in a deflationary spiral for decades, and from talking to fellow travellers it seems that the cost of living in SE Asia hasn’t increased in the past 20 years at ALL. So even if the price of cabbage spikes in New York, you can always just switch countries to one where your dollar goes further.

What if your 5-year bucket runs out?

If your 5 year bucket runs out, then we’d have to start selling assets to fund our living expenses. And that would be bad. However, keep in mind that the average length of a recession in the 20th century is well below 2 years. In the first half of the century, recessions lasted on average 18 months, and in the 2nd half (as central bankers and policymakers figured out how to better combat recessions), they lasted on average only 10 months (source). The Great Depression of 1929 only lasted 3 years 7 months, with every other recession after that lasting significantly shorter.

So are we going to see a depression lasting longer than 5 years? Maybe. But most likely not. In fact, given the average length of recessions excluding the Great Depression, there’s an argument to be made that 5 years is way too conservative, and that maybe 3 years is more appropriate. But whatever, I’m comfortable with using 5 years as my safety margin. You can decide for yourself how long you want yours to be.

Onto the next section!

Go back to the previous section


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Disclaimer: The views expressed is provided as a general source of information only and should not be considered to be personal investment advice or solicitation to buy or sell securities. Investors considering any investment should consult with their investment advisor to ensure that it is suitable for the investor’s circumstances and risk tolerance before making any investment decisions. The information contained in this blog was obtained from sources believe to be reliable, however, we cannot represent that it is accurate or complete.

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