New ISA year musings

So it’s been a new ISA year, about 10k to put in, possibly 17k if I can save that much and still avoid paying 40% tax via AVCs. In theory I should be able to do it.

I want income, which tends to mean going for steady, boring companies that make stuff that it’s hard to do without. I generally look for something that pays a dividend yield of 4.5 to 6%, and hasn’t had any dividend scares in the last few years. The latter requirement is a big ask in this post credit-crunch world.

I try not to do PEs of more than 15 (that is the long term average for the FTSE 100 ISTR).

I want to buy and then hold – if the income remains at about 5% of what I paid for the holding I am happy, though of course I hope over the long term for the share price and dividend to slowly drift up broadly in line with inflation, otherwise I might as well buy bonds.

And hopefully the volatility of the dividends, when averaged across my entire holdings, will be less than the volatility of the share prices. For holdings that meet these requirements, I aim to purchase in lumps of about £3k, preferably using iii’s £1.50 lumped dealing service. That keeps costs manageable and I don’t end up with more than about three of four stocks to know over a year.

For any major asset class if I can I would like to have at least two typical companies in the field. That is why I have GSK and AZN for my pharma holding, for instance. If I had oil I would have BP and RDSA.

The income seeking puts me in the territory of elephants. These suckers aren’t going to gallop, I am not going to wake up one day to see a share price five times higher than it was the night before. Sadly there is some risk I’ll see the converse at some time, though even BP in its annus horibilis didn’t take that sort of hit. I am comfortable with that – I am not a young pup at the start of my career trying to build my pension taking risks everywhere to try and make the annual savings lower. And I will need the income soon – within two years.

Using PE is very old-skool compared to using PEGs and CAPE and the sort of stuff described here which sounds like it should be a lot more ‘real’ – but having read the page twice I can’t understand it. I recognise some similarities with this approach which I can sort of understand. My shares universe is small, limited by my requirements and so I accept the imprecision of my tools, as long as I generally get results that work for me in terms of steady dividends of about 5% of my original stake then fine.

I would far prefer to use use investment trusts for income, particularly as I could use the smoothing where I am particularly exposed in trying to live off my investment income in the two to five-year time-frame. But I don’t buy those at a premium and unfortunately that seems to be the way things are for the equity income trusts I am interested in, Mr Market is in an overly bombastic mood on that front. I hate doing the grunt level work of dealing with individual holdings, but needs must at the moment.

In doing this, I am making an implicit bet that the financial system can preserve wealth across the years. My worldview is such that I think there is a serious risk of that assumption failing dismally. That is why I have non-financial investments. I therefore accept that there is a small but finite risk of my entire financial holdings being destroyed if the financial system is overwhelmed by a black swan event. More likely, it will be overwhelmed by the terminal challenge to the fundamental axiom of capitalism – the need for continuous growth. That challenge will come as oil becomes more expensive year on year as it becomes harder to extract. Yes, we may head it off with thorium reactors or solar PV. Well, maybe not the latter, solar PV in Britain? You must be joking, and David McKay says it can’t be done.

So, how should I play this? Well, I have bought some shares for about 3k from this year’s ISA. The rest I will hold as cash for a little while, as I am hoping for some buying opportunities when:

  • Greece finally takes that razor to the bond markets and reinstates the drachma.
  • Ireland at least restructures the debt, though the days of the punt must have some fond memories in Dublin.
  • The Portugese escudo returns

I figure 2011, probably the second half, holds a good opportunity for this, wich should hammer share prices.

Then, of course, there’s the Big One. If that blows, it could shatter the financial system, but if it holds then the levels of fear and loathing stalking the Western world will be truly awesome to behold. We won’t be able to tell night from day, or who or what to trust to store value.

That Big One is the dollar’s reserve currency status being revoked or usurped. The world was dumped on from a great height when John Maynard Keynes’ Bancor was switched for the US dollar at Bretton Woods.

If that happens all bets are off. I don’t know if any currency will hold value, or if when the kingpin is pulled out the whole system will fall apart, the falcon will hear the falconer no more and the numbers will drop from my dealing screen like the opening credits of The Matrix. OTOH there may be money to be made in the confusion, as well as a good deal to be lost.

Sooner of later the world will wake up and realise that the conflicts inherent in having a national currency as a reserve currency are toxic, to both the nation and to the world. It is moral hazard writ large, an invitation to run a continual deficit at the expense of everyone else.

However, to start off with, a jolly good Euro crisis should be more than good enough to paste the stock market and improve values!

PS Since writing this it seems an update to Monevator’s HYP is on it’s way. Which hopefully will inform my thinking on this. I hadn’t expected to have to use individual shares in a HYP, as I had anticipated using income investment trusts. Unfortunately they are poor value at the moment because they are trading at a premium, presumably because everyone else is chasing investment income at the moment because of the atrocious return on cash.

Here in the USA, I’ve seen income investors bidding up REITs. One of my second-tier REITs went up 20+% since the beginning of the year… I’ve reduced holdings in it as it’s income just isn’t as stellar as the price would indicate.

A preliminary thought is that you should also consider companies with a lower yield in the 2.5% – 4.5% range. With dividend growth, these may be a better longer term bet, given that there is often a reason for above average yields. That said, I have a fair few high yielders myself.

I agree that staging any purchases is a good strategy at the moment, owing to the Eurozone problems, but I think that defaults and further banking crises are more likely than the Euros’s demise. The most sensible outcome, the restoration of the Deutschemark, is the least likely to occur.

@George, same here, looks like we share common financial pathologies, though the change isn’t so much. I have one REIT even though anything to do with property scares me, but the yield was/is attractive….

@SG can’t argue with the principle, but my problem is I will have a very serious income shortfall between 2012 and 2015, where the income from my ISA will be my only income. AFter that I may well rebalance along those lines, though who knows what 2015’s stock market will look like. SO I need yield in the near future, heck, I am even considering a bond element 😉

Not sure how defaults will work in the Eurozone with all the stupid guarantees of the unguaranteeable, the whole thing seems riven with fault lines they’re trying to patch across. In the end the Greeks don’t want to work as hard as the Germans and they’ve run out of places to hide that inconvenient truth. The Germans are probably also feeling nostalgic for the DM!


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