How to Get Higher Income Now That Cash Interest Rate is Falling? Find Dividend Income Funds?

I have a friend who pinged me regarding his financial situation.

He feels that his current cash allocation of $580,000 is rather high and wonder if it is a good idea to move some to dividend stocks or equivalent to get some passive income. Currently, he does not have a income from work. He works on something but it is not paying him.

He rents out his HDB flat for $1,600 a month. The $580,000 in cash is spread among Singapore Savings Bonds and 6-month Treasury bills. That would give him some good interest income.

The problem to him, is that the market interest rate has been dropping so… that means that his income is dropping. This is the main reason he is thinking about looking into dividend stocks or equivalent to provide the spending income.

My friend shared that his expenses is $2,000-$3,000 a month but there are perhaps a couple of months where his expenses will jack up to $5,000-$6,000 a month due to equipment repair, one-time taxes and visas.

I known him for sometime. The first time that I met him, we did a stock take of where he sees life in the future, what he wish to achieve. We did a financial stock take of his situation then and whether the money can support the life he wants and if not, the possible or potential trade-offs that he can make.

I understand his affinity towards certain investments, how he frames financial security in his mind.

This post is what I will share with him, which will hopefully help him in some ways.

The Most Effective to Generate Passive Income for Him

I am not going to change my tune what I told him years ago. This is also not going to be very different from what I shared on Investment Moats:

1. Have a portfolio of 40-75% equity allocation.
2. The rest be in fixed income / cash.
3. Plan to spend 3% of the initial portfolio value. This is the recommended income to spend for the year.
4. Adjust the recommended income for subsequent year’s spending based on the previous year’s inflation rate so that your income retain the purchasing power.
5. Finally, have a layer of safety check to adjust the recommended income based on market condition. If the market is not doing well, he might want to keep the recommended income without the inflation adjustment. Check whether the income drawn divided by the current portfolio value is less than 7-8%. This is to prevent him from spending too much, so much so that it will impair his portfolio prematurely.

This is roughly how his current assets look like, without his CPF and HDB flat:

I didn’t include his CPF because his CPF is mainly in CPF SA, and MA. The Medisave is for his future medical expenses and he has reach CPF FRS for this CPF SA. Eventually, the money in CPF SA will go over to his CPF RA, which will eventually be part of his CPF LIFE annuity income.

I estimate his outstanding mortgage is about $260,000.

If you are confused how to plan for yourself, it is always easier if you figure out if you are financially independent, how would you want your setup to be? Do you want live in the current home or get a smaller/bigger place? Do you want a peace of mind without having a large inflexible mortgage expense?

I think a setup with a greater peace of mind would be one where he assumes he can pay off his mortgage anytime. This means instead of $1.4 million, the amount of money he can think about generating income is actually $1.16 million.

The nice thing is that if he don’t wish to pay off his mortgage, the $260,000 in SSB or Tbills may be able to earn an interest of $5,200 a year based on a return of 2% p.a. I think it is safer to keep them in SSB or TBills.

Now if we look at the rest ($1.16 million), the equity allocation is about 68% of $1.16 million. If I am right, currently he is invested in iShares Core MSCI World UCITS ETF (IWDA). I think this is adequate equity allocation. Perhaps he can consider deploying the rest of the cash into fixed income.

Suppose we assume that this is the first year he will take out income from his portfolio, a recommended income will be $1162000 x 3% = $34,860 yearly or $2,905 monthly. We plan for this income to retain his purchasing power.

If we add $1600 to this, then the income he can work with is $4,500 a month and he needs $2000 to $3000 monthly. His portfolio at this stage is pretty well setup.

If so, what is the problem here?

Get Past the Concept of Only Spending Income Given to You

Based on how a person describes their plan income, their portfolio, I will get a feeling how they look at things.

My friend views that the only income that he can spend is the income put nicely into his bank account. If he needs to sell units from his IWDA or take from his cash capital, that is not a safe plan.

What my friend feels is not too different from many of you.

I think it is a major mental block and why not everyone would be able to accept this kind of income strategy.

My friend once shared with me why he feels secure to invest in equity. If he can spend from the income from the rental income, the interest from SSB and Tbills, it allows his IWDA to grow.

If that is the case, WHEN are you going to touch your IWDA?

It is not like the IWDA have not done well. Since he has invested for the past 4-5 years, the returns are almost 60-77% up. Surely it is safe to just spend like 5% of that?

I am not forcing my friend to spend. I am asking under what conditions will he touch that IWDA. If he plans to never tough that IWDA equity allocation… then maybe his portfolio is only $365,000 (his cash and fixed income)?

I think how we frame our investments in buckets, in received income, selling units is what is the main problem.

And this is where I have limited help with.

I already explain why this is a relatively conservative thing (if he ever remembers). Whether he will ever feel convicted enough to implement this or not will depend on himself.

I don’t think it is always healthy to pressure people to use an income strategy that they are less convicted in. But how would he be more convicted?

I think we all have to take the journey ourselves to do that work and really understand why this is a sound strategy. This means not listening to Kyith but using what Kyith said as a guide and figure out what the materials are trying to say.

If my friend doesn’t figure out, I think it may be better to just switch from IWDA, which is an accumulating class of shares to something else that provide income to him.

If not, I don’t think he would ever touch those IWDA shares.

What Kind of Dividend Income Paying UCITS ETFs Should He Go For?

My friend made it clear he is not comfortable with individual stocks.

This means that we are left with managed funds in the form of unit trusts.

Now here comes the challenging part. What are the characteristics of a dividend paying fund that you look for here?

The simple answer is if he is comfortable with IWDA, he can stick with that philosophy and invest in the distributing class of the iShares Core MSCI World ETF (IWDD). This fund is pretty new and incepted in Jul 2023.

The last historical income yield is 1.34%.

I suspect that my friend will find the income to be too little.

If he has similar global philosophy, then he can go with the MSCI World High Dividend ETFs that I made videos about not too long ago:

Link

Link

VHYD, or The Vanguard FTSE All-World High Dividend Yield UCITS ETF USD Distributing, currently has a historical income yield of 2.96%. That might be high enough for him.

But then the issue comes with the residual questions:

“But Kyith, how is the historical performance of these ETFs?” “Does the NAV go down?” “If I spend just the income, will I have the income I need, yet last for the period I need?”

The quick answer is I don’t know. He has to find out. I am not his adviser.

Most importantly, he needs to rearrange some stuff in his head when it comes to

1. How do these ETFs fit into his income plan?
2. What are the critical things he should be looking out for when evaluating these ETFs?
3. How does he make sense of performance now that he owns something that provides income?
4. How does he deal with a period where the fund NAV goes down or doesn’t grow?

To help him, he can take a look at the factsheet if he Google “MSCI World High Yield”, which will bring up this factsheet of the MSCI World High Yield Dividend Index as the first entry:

The performance is not exactly VHYD but close and you can see that in the recent years, it has underperformed the MSCI World index but earn a respectable 7.6% in total returns a year.

How should he sees this? Again, something different to deal with.

Now in another timeline, if he asked me the same question and his affinity towards Real Estate Investment Trusts (REITS), I would tell him that there is a local NikkoAM-StraitsTrading Asia ex Japan REIT ETF, or CFA for ticker symbol. He can own all the large REITs such as Link REIT, Ascendas REIT, Mapletree Logistics and Keppel DC REIT.

The current income yield is 6.0%. If it is two years ago I would say the yield is 5.3% (I actually did a post on the 3 REIT ETF in 2023 here)

He has to contend with something different. Here is a chart of CFA’s NAV:

The past 6 years have not been kind to REITs and if he followed through with what I suggested hypothetically his question will be “Kyith, do you think I should still hold on to the CFA? The value of my equity keeps going down.”

And I would reply “But it gives you the kind of income you want isn’t it?”

“I am afraid that if this doesn’t stop, my portfolio might not last so long.”

And my reply would be “There are going to be long periods where a sector doesn’t do well. REITs is a real estate buy-to-let sector by itself. The long term return of REITs is the same as MSCI World. In fact, the returns are slightly better. There are some investors who are going to live through a period where the performance of equities, or a particular sector don’t do well. You might be in one. If you are diversified enough, it will recover over time.”

I am not sure if this will work well for him.

I seen how the confidence of people investing in a REIT ETF like CFA changed. They started wanting income and want to dollar cost average into it. Then they stop because they questioned the move. And I explained the same way.

The truth is that every shit goes through this and whether you are less lucky to see the ugly shit.

But you should expect it.

My friend should even expect his IWDA (MSCI World) to do something like this. From 1999 to 2009, an IWDA would have done 1.0% p.a. for ten years.

He has to dig in to find out where his conviction in equities, or in fixed income comes from, such that it allows him to remain invested in almost $800,000 in equities. And he has to get through the residual questions about how does this ETF work better than his current plan.

Does He Want a More Sustainable Long Term Income Model?

I wonder if it comes as a shock to him that the income he gets from Singapore Savings Bond and Treasury Bills is volatile.

Intuitively, this should be obvious to many in my opinion.

But I suspect the lured of safe, non-volatile capital and high interest cash is too much such that people think less of it.

I have invested for almost 20 years at this point, and work in wealth advisory for 5 years and the following are a list of truism of income:

1. There is some form of volatility and uncertain that you have to deal with period.
2. Cash-like stuff is safe but the long term returns are low.
3. The income you get from cash-like stuff is also volatile.
4. Short-term fixed income as a basket is relatively safe as well, but the income is also volatile because the underlying fixed income matures fast and their coupons are volaile.
5. Investment-grade, or high yield fixed income matures and when they mature you faced reinvestment risk that the coupon that you get is different from the previous one.
6. Rental income goes up by 30% and goes down by 30% at least.
7. There are periods where you can only be a price taker because there is excessive rental supply.
8. Dividend income can go up steadily at 3% to 10% a year but they can get cut suddenly if the underlying companies don’t do well.
9. You can go with high yielding dividend securities but they are high yielding for a reason because either they have some issues and therefore they are trading at a high yield or that they can truly pay a high yield. If it is the former, is this it? Is this the point that the issues are irrecoverable and they start going downhill or is it a fixable problem? If you concentrate on a few of these stocks, you will spend your days thinking (and hoping) around these uncertainties.
10. The income of an equity or fixed income-based unit trust is volatile because of two reasons:
    • The income is based on the distribution of the underlying securities and the payouts of the underlying securities is always volatile.
    • The manager of that fund has a mandate but they are not your financial adviser. Their objective is to make sure the fund doesn’t die not to firstly give you income.
    • If they give a guarantee that the income is consistent, or index to inflation, that is a huge and challenging obligation which is hard to keep to for them. Thus, it is their interest NOT to make these guarantees or write this into their mandates. It is always safer to tell people that they pay out what they can pay out (whatever that means).
11. You can get distributions from your private investments. Part of it is your own capital and part of it is the real income or your gains. You have to be able to make sense which is which, if you don’t want to spend them down.
12. Income generated from options premiums is volatile because
    • Implied volatility, which determines how much options premiums you can sell at, changes.
    • The probability that the underlying security (a stock or an index) expires in-the-money or out-of-money changes during the different time period you write at, but also on a trading day basis.
    • It is very common that you made 1-3% a month for a few months, only to give a lot of it back when the probability goes against you.

What all this means is that there is some sort of income uncertainty that you have to contend with. There are some degree of effort that you would take, some sophistication you would venture into.

But the critical question my friend will need to ask himself is: If everything is uncertain, how do I create a long term sustainable income model for myself?

If he doesn’t answer that question, then this thing is not as passive. Passive is a lie because he would have sorted this part out for a while, only for a change in value or nature of income to put another worrying question in his mind.

He will feel like he is living his life fighting income volatility fire on a frequent basis.

If he encounters volatility with his long term rental client, that will be more stressful as well.

The solution to this is to smooth out the volatility in some ways. But how to do it? That is probably a rabbit hole down to it.

I provided the smoothing system in that safe withdrawal rate framework already. But if people don’t understand it… and cannot relate to these income uncertainty truism… they will need to craft their own smoothing system.

He Needs to Frame His Spending/Income in a Better Manner

Different people look at their spending differently and based on what I see, I can kind of tell a little.

If you tell me that your spending is $2000-$3000 monthly, but that there are months where your spending suddenly go up to $5000 monthly, I will tell you that you need $60,0000 a year in income this year and that having $1.1 million might not be really enough to last more than 50 years.

We are rather flexible people when it comes to spending generally but do we look at our planning this way?

The challenge with income planning is that

1. The underlying assets that generate the income tend to be uncertain.
2. Your income spending is uncertain.

Added together, the whole plan will have a spectrum of outcome with one end doing very well and the other end where my friend will run out of money prematurely.

You can control the selection of the assets you use to generate the income to control the uncertainty. The biggest control may be the spending income part.

My friend would have to find a better structure.

I look at most of my planning as an annual thing. There are spending that is not a surprise and has to plan for. If you want this lifestyle of renting, you got to be prepared for rent to go up by 60%. This was what the local folks suddenly have to face with.

The shock comes from being surprise the volatility can be -60% +60%.

Things will break down. He has to plan for the maintenance of his HDB flat and the equipment he use. Every year, even though he is not spending he needs to constantly fill up a bucket that will eventually pay for these lumpy spending.

How he looks at his income needs, will drive peace of mind.

Recently, my friend Cents of Independence wrote about how a conversation with me change how she groups her spending a little:

I just explain that there are some of her expenses that are more work-related and they are there because they are the capex for work, and would go away if she decides not to work eventually. This creates more flexibility in her 2025 budget but also the figure in her mind about how much long term income she needs her portfolio to provide for.

We all prefer to be able to spend freely in our retirement, but we can spend more freely if we have crafted sound structures and considered better.

I think my friend will do okay.

I suspect part of that $2000 to $3000 monthly that he needs are about $1000 in mortgage payment and that goes away if we are considering the prospect of setting aside $260,000 just in case we pay off that mortgage. So a spending without the mortgage is closer to $1000 to $2000. The highest might be $32,000 a year.

Conclusion

I think these are some areas for my friend to think about.

Most of my answers are not straightforward because most things are not so straightforward. If my friend has $3 million instead of this, then a lot of these problems might go away. But we all don’t always have 3 million.

Having $3 million makes the problem go away at the tier of spending my friend is at but that would still be a problem for many with more extravagant spending.

Which is why sometimes it is straight forward sometimes it is not.

Hopefully, this is helpful for some of you with rather similar problem as my friend.

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Kyith is the Owner and Sole Writer behind Investment Moats. Readers tune in to Investment Moats to learn and build stronger, firmer wealth foundations, how to have a Passive investment strategy, know more about investing in REITs and the nuts and bolts of Active Investing.

Readers also follow Kyith to learn how to plan well for Financial Security and Financial Independence.

Kyith worked as an IT operations engineer from 2004 to 2019. Currently, he works as a Senior Solutions Specialist in Insurance Start-up Havend. All opinions on Investment Moats are his own and does not represent the views of Providend.

You can view Kyith’s current portfolio here, which uses his Free Google Stock Portfolio Tracker.

His investment broker of choice is Interactive Brokers, which allows him to invest in securities from different exchanges all over the world, at very low commission rates, without custodian fees, near spot currency rates.

You can read more about Kyith here.