Managing Your Passive Dividend Income

The Bedokian Portfolio’s mantra is “passive income through dividend and index investing”. During the portfolio building phase, staying the course of dividend and index investing (peppered with some growth and value styles if you deem fit) through the ups and downs of the markets is correct; some years you will get more, others you may get less. However, if you are presently at the passive income phase, and with down periods such as the ongoing COVID-19 situation, your dividend income stream will definitely be affected one way or another (assuming you have no other forms of income stream).

 

Though I have yet to reach the passive income stage, I have a plan in place to execute it. The plan involves knowing exactly how much you would have in the coming year, so in lean years like this, I would not be caught off guard. In other words, I need not worry on the lesser amounts of dividends I am getting this year, and I will be less worried next year because I knew how much I am going to have.

 

So, what is the secret? It is pretty simple actually. The dividends that you are getting this year is going to be your next year’s income.

 

To practice this, you would have to start on the day that you have decided to convert your portfolio into a passive income machine. Or, if you want to continue working, to step down from the rat race and do a job that you really like, without pressure. And no, that “day” is not going to be your last working day, but it is the day which you decide to quit in exactly one year’s time. In this 365-day (or 366-day if leap year) duration, your income is from work, while the dividends collected from your portfolio will form up your next year’s income (instead of going into the cash component of the portfolio). After the year is done, you quit and start to treat last year’s dividends as your current year’s pay, while this year’s dividends will be next year’s pay, and so on.

 

The main advantage here is that you will suffer less from income shock, since you knew how much you will be having. A year’s head start gives you ample time to plan ahead and decide if you should live lean (e.g. forego an overseas trip or a big purchase), drawdown further from your portfolio and/or take up some gig or job stint to cover the shortfall. On the investment front, if last year was a bumper crop and this year is down, you can make use of your last year’s enlarged dividends to buy undervalued securities in the bear market to enlarge your portfolio.

 

For those who had begun their dividend income journey, I believe you already have a plan in place and it could be working well for you. However, if you decide to shift to the method above, then the “work income” for the initial year may need to be drawn from your portfolio if you are currently not working or the work income is not enough to supplement it.

 

To formalize your dividend income further, you may want to implement the concept of a monthly pay by dividing the total amount by 12, treating it as a salary to be drawn every month. Since most of us are/were salaried employees, it could reinforce prudent spending and savings (and investing) that we were so used to, even if we are really not working.

Straits Times Index And Real Estate Investment Trusts

On 4 June 2020, FTSE Russell, Singapore Press Holdings (SPH) and Singapore Exchange (SGX) had announced in their quarterly review that Mapletree Industrial Trust had replaced SPH as a constituent of the Straits Times Index (STI)¹. The changes will be applied after business hours on 19 June 2020 and will be effective on 22 June 2020. 

 

What caught my eye in the same article was the STI reserve list (the next-in-line substitutes should the current constituents are to be dropped in the next review), and out of five listed, four are real estate investment trusts (REITs). There were already five REITs in the STI, and with this impending change, there are going to be six.

 

For the Bedokian Portfolio, as well as the other investment portfolios, the STI served as the representative of the Singapore equities asset class. Depending on your school of thought on asset classes, some viewed REITs as a separate one due to physical properties being a standalone asset class, and REITs are a hybrid of physical properties with equities characteristics (a view that I am holding). There are others who viewed REITs as a subset or sector of equities and hence they are treated as such. Therefore, seeing the number of REITs on the STI reserve list, we may need to relook at how to position your Bedokian Portfolio if you view REITs as a separate component and use the STI only for equities.

 

The STI-REITs Overlap

 

Using data from the SPDR STI ETF, one of two ETFs listed in SGX that track the STI (for information, the other is the Nikko AM Singapore STI ETF), the weightage of REITs only (property sector companies are not included) is about 11.91%². Factoring in the balanced Bedokian Portfolio (35% equities, 35% REITs, 20% bonds, 5% commodities and 5% cash) and extrapolating the 11.91%, a swing of 4.17% (35% x 0.1191) would favour REITs from equities, making it an equities-REITs ratio of 30.83% : 39.17%, and we have yet to add the incoming Mapletree Industrial Trust. This meant that inadvertently, your Bedokian Portfolio is overweight on REITs, even if you have equal portions of STI ETF and REITs (see Fig. 1).

 

Fig.1 

 

With Singapore becoming a REITs hub and mergers happening (or happened) between REITs, this asset class (or sub asset class) will become a major ingredient in the STI recipe. The proposed merger of Capitaland Mall Trust and Capitaland Commercial Trust (both are in the STI) would create a vacancy in the index, and it is likely going to be another REIT coming in (assuming the reserve list remains the same). This may cause our portfolio balance to be lopsided much more to the REITs end.

 

It is OK if you choose to leave it as it is or if you agree on the viewpoint that REITs are equities. If not, there are two main ways on bringing the balance back:

 

#1: Buy More STI And Reduce The REITs

 

In order to mitigate the overlapping of REITs into equities as shown in Fig.1, a reverse overlap can be done as shown in Fig.2. To do this, we need to buy more STI ETF and less REITs until to the point where the actual weight is more or less equal with each other. This, to me, is the easiest for passive investors but there is the additional hassle of checking periodically the actual holdings of the STI ETF that you are invested in (whether the SPDR or the Nikko AM one) to see if the allocation is in sync or not.

Fig. 2

 

#2: Core-Satellite Approach

 

The concept of the core-satellite in the Bedokian Portfolio is where ETFs that represent the various asset classes form the core while individual securities form up the satellite. The inclusion of individual securities will dampen the overlap issue (see Fig. 3) since you can dictate the types of securities you can hold. Assuming your ratio for the core and satellite is 50:50, on the weightage level, the swing to REITs will be less pronounced at 2.08% (35%/2 x 0.1191), which is not so significant in affecting the equities-REITs balance. In this way you can continue to have that allocation or make some fine adjustments between the core and satellite numbers to manage the swing.

 

Fig. 3

If you are a passive investor and analysing companies is not your cup of tea, then you can replace the individual securities part with regional/country/sectoral ETFs instead, as long as they are under the equities category. There are tons of such ETFs available from the major stock exchanges in New York and London, and SGX has a variety, too.

 

Stay safe, stay invested and stay diversified.

 

1 – Straits Times Index (STI) quarterly review. FTSE Russell. 4 June 2020. https://www.ftserussell.com/press/straits-times-index-sti-quarterly-review-9 (accessed 16 June 2020)

 

2 – SPDR Straits Times Index ETF. State Street Global Advisors SPDR. Month-End Holdings as at 31 May 2020.https://www.ssga.com/sg/en/individual/etfs/library-content/products/fund-data/etfs/apac/holdings-monthly-sg-en-es3.xlsx (accessed 16 June 2020)

 

References

 

Ground Rules. Straits Times Index v2.5. January 2020. https://research.ftserussell.com/products/downloads/Straits_Times_Index_Ground_Rules.pdf (accessed 16 June 2020)

 

Zhen Hao, Toh. In Singapore, REITs Are Becoming More Important Than Ever. Bloomberg. 24 Feb 2020. https://www.bloomberg.com/news/articles/2020-02-22/singapore-s-reit-hub-ambition-pays-off-with-most-foreign-ipos (accessed 16 June 2020)

 

Bob And Staying Long Term

If you do not know Bob, he is our sample investor who started off passive investing through ETFs following the balanced Bedokian Portfolio allocation (35% equities, 35% REITs, 20% bonds, 5% commodities and 5% cash, see here) starting from 1 Jan 2017. He rebalances his portfolio every six months with SGD 5,000, usually at beginning January and end of June. After close to 3.5 years, as at 9 June 2020, his overall time weighted returns are at 13.11% (based on calculations from StocksCafe) to date.

We had seen the fall and subsequent rise of the equities’ and REITs’ prices between end February till now, and some of us may have entered during the lows of end March. Notwithstanding the concerns on the disconnect between the markets and the economy in general, you may have wondered if Bob had bought in during that down-down period, he would be getting a better bargain than at his scheduled upcoming rebalancing date of 30 Jun 2020. As an active investor, naturally I would have felt a sense of waste and opportunity cost imposed, but we know emotions are a no-no in the world of investing and trading, so we just looked back, sigh and moved on (I called this moment “the one that got away”, but honestly I did get some counters on the cheap during that period). 

For Bob, since he is only looking at his portfolio once in a while, I guess he may have other more pressing concerns during this time, such as worrying for his job, the safety and well-being of his family and coping with the isolation and boredom resulting from the circuit breaker measures. Of course, Bob might have heard from his social media channels and friends about the stock market, and the fear and opportunities that come with it. Probably he is just taking it in his stride and believe in the long term.

The Long Term

And this is precisely what I am going to talk about. Investing is meant for long term, and by my definition it is a period of at least 10 years. Ups and downs, peaks and troughs, are part and parcel of the market and economic cycles, and over the long term you are likely to get overall positive returns. During the timeframe of Jan 1994 to Dec 2019, using the balanced Bedokian Portfolio with U.S. based asset classes, a USD 10,000 investment, rebalanced annually, will return USD 50,145 (inflation adjusted). If we look at the 10-year rolling returns, it resulted in a range between 4.92% and 11.58%, with an average of 8.36%¹.

Let us stretch a bit longer using only U.S. equities and 10-year treasury bonds (60%/40% respectively), from Jan 1972 to Dec 2019, an initial USD 10,000 (rebalanced annually) will return USD 130,424 (inflation adjusted) and the 10-year rolling returns were between 3.32% and 15.69%, averaging at 10.29%². The figures were considered not bad, as there were a number of economic crises in those years besides the all-too-familiar Dot Com Bubble and the Global Financial Crisis (e.g. 1973 Oil Crisis, 1987 Black Monday crash, etc.).

When you look at the graphs and charts of equities, REITs or maybe bonds, first by the day, then by the week and the month, the peaks and valleys are pretty obvious, but if you continue to zoom out by a year, then five years and then ten, chances are you will see an upward slope, generally. This is what you want to achieve for your portfolio; the gain in price and value. These are made possible because of two important and simple factors: the inherent growth of the economy and the power of compounding. 

Using the world’s gross domestic product (GDP) as an indicator of economic growth, since 1961 till 2018, annually it had always been a positive percentage growth with the exception of 2009 (see Fig. 1)³. If this GDP is an investible financial instrument, you can see the compounding effect work over the years.

Fig.1 - World GDP growth (annual %), 1961 - 2018. Source: World Bank

Therefore, in investing, stay calm and long term, and be diversified.

1 – Statistics from Portfolio Visualizer (www.portfoliovisualizer.com), using Backtest Asset Allocation. 35% US Stock Market (equities), 35% REITs, 20% Total U.S. Bond Market (bonds), 5% Gold (commodities), 5% cash. Starting year of 1994 was selected as it was the earliest year with REITs data.

2 – ibid. The U.S. Stock Market and the 10-year Treasury bond were selected for the equities and bond components respectively, since these two contained data from 1972, which was Portfolio Visualizer’s earliest data point year.

3 – GDP growth (annual %). The World Bank. https://data.worldbank.org/indicator/NY.GDP.MKTP.KD.ZG?end=2018&start=1961&view=chart (accessed 9 June 2020).