Investing when someone else gets all dividends

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VaR
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Re: Investing when someone else gets all dividends

Post by VaR » Tue Jun 12, 2018 11:19 am

ibhhvc wrote:
Tue Jun 12, 2018 5:57 am
I finally got to take a deeper look into the trust document. It specifies that "all of the net income" be distributed to the fourth party. After they pass, the trustee shall distribute the "remaining trust property" to the first three parties pro rata.

The trustee is also tasked to "determine in a fair, equitable, and practical manner what will be credited, charged, and apportioned between principal and income". That's about all the instruction there is.
I can't help but think that there is some phrase in the trust document that explains the intent of the trust and thus the duty of the trustees. Not the mechanics as above but the intent.

For instance, I'm not unlikely to have a trust created for after my death where the income goes to my wife and the principal is remaindered to her kids. But the primary goal of this is steady life income to her and I won't care much if there is a remainder for the kids. She can always spend less than the income and remainder the rest of the estate to them. They key aspect is that the assets are properly managed for a life income.

The trust intent might be different if I were unmarried and leaving the income to my sister and the remainder to her kids and she didn't really need the money.

CnC
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Re: Investing when someone else gets all dividends

Post by CnC » Tue Jun 12, 2018 11:27 am

VaR wrote:
Tue Jun 12, 2018 11:19 am
ibhhvc wrote:
Tue Jun 12, 2018 5:57 am
I finally got to take a deeper look into the trust document. It specifies that "all of the net income" be distributed to the fourth party. After they pass, the trustee shall distribute the "remaining trust property" to the first three parties pro rata.

The trustee is also tasked to "determine in a fair, equitable, and practical manner what will be credited, charged, and apportioned between principal and income". That's about all the instruction there is.
I can't help but think that there is some phrase in the trust document that explains the intent of the trust and thus the duty of the trustees. Not the mechanics as above but the intent.

For instance, I'm not unlikely to have a trust created for after my death where the income goes to my wife and the principal is remaindered to her kids. But the primary goal of this is steady life income to her and I won't care much if there is a remainder for the kids. She can always spend less than the income and remainder the rest of the estate to them. They key aspect is that the assets are properly managed for a life income.

The trust intent might be different if I were unmarried and leaving the income to my sister and the remainder to her kids and she didn't really need the money.
As I said this probably is income for a 2nd wife who may have her own children. He wants his legacy to go to his children. But he doesn't want his wife to be left in the cold.

To me it makes sense. If my wife and I built our life together and I pass in my 50's and she remarries. I could certainly see her leaving in her will everything to her and my children. But allowing the stock dividends to go to the guy she married as a widow so he doesn't get the shaft.

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vineviz
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Re: Investing when someone else gets all dividends

Post by vineviz » Tue Jun 12, 2018 11:53 am

CnC wrote:
Tue Jun 12, 2018 11:17 am
vineviz wrote:
Sat Jun 09, 2018 9:11 am
It sounds like a really terribly constructed trust if, when the trust dissolves it goes to the current trustees.
Not really terrible. Take into account a man with children remarries. He wants to leave everything he has to his children.

But, he feels an obligation to take care of his second wife so he is going to give her the dividends until she dies.

I'm fairly certain this is what the situation was.
I have no difficulty imagining how or why such a trust might have come into existence. While I doubt the competence of the lawyers that formed it, I don't doubt the best intention of the person whose assets it represents.

A trust in which (some of) the beneficiaries act as the trustees creates an inherent conflict of interest. Having a professional fiduciary act as trustee avoids this, of course, but even without one the conflicts of interest are not necessarily insurmountable Naming a neutral co-trustee or trust advisor, for instance, is often very effective (and also permits decisions to be made if one of the existing trustees is incapacitated and the other two can't agree).
"Far more money has been lost by investors preparing for corrections than has been lost in corrections themselves." ~~ Peter Lynch

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David Jay
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Re: Investing when someone else gets all dividends

Post by David Jay » Tue Jun 12, 2018 11:57 am

Invest it all in BRK B :twisted:
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

cas
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Re: Investing when someone else gets all dividends

Post by cas » Tue Jun 12, 2018 11:59 am

Do with this information what you will (since it seems completely out of line of where the conversation seems to want to go), but here are some observations from real life experience with an actual (small) trust that is more or less set up like the trust the OP speaks of. I'm not expert. I've just had conversations with the corporate trustee from time to time about why the investments are managed the way they are. Unlike me, Gill is an expert who has seen lots of trusts, so pay more attention to what he says that what I say.

In the case of the trust I know, the income beneficiary gets the income. There are remainderman beneficiaries that get what's left after 2 generations are skipped. A difference is that the income beneficiary (rather than a remainderman) is a co-trustee with a corporate trustee/investment manager.

In any case, the corporate trustee/investment manager seems to operate mostly under assorted state laws that govern investment possibilities. (After 4 or 5 mergers/acquisitions/take-overs over the decades, the corporate trustee/investment manager is currently the trust department of one of the massive too-big-to-fail banks.) In a legal sense, as far as I've seen, trustees aren't left to their own devices nearly as much as the above discussion seems to assume. With the caveat that laws vary from state to state. And with the caveat that enforcing law on a straying or deliberately uncooperative trustee (especially an individual one) requires lawyers and courts, which is very expensive.

My non-expert understanding:

When the trust came into existence in the 1950s it was governed, I think, by the Prudent Man Rule (see wikipedia "Prudent Man Rule"). (Parts of the conversation above (e.g. "maybe it should all be put in TIPS") seem to want to think like the Prudent Man Rule.)

But times and the investment landscape changed, and problems arose with trusts governed under the Prudent Man Rule (Prudent Man Rule tended to lead to very conservative investment portfolio (e.g. lots of US Treasuries and very little stock) that led to a joke: "How do you make a small fortune? Give a bank a large one to manage in trust." ( e.g., p. 1 of http://www.law.harvard.edu/programs/oli ... ff_580.pdf )

So in 1992 the Uniform Prudent Investor Act came along to replace the Prudent Man Rule and govern the investment decisions of trustees, and most states have adopted some version of it. (See wikipedia "Uniform Prudent Investor Act"). Diversification, total return, and Modern Portfolio Theory became the focus of portfolio management fiduciary duty for trustees. As a corollary, I think, to the "diversification" aspect, the corporate trustee I deal with tends to get all hot and bothered about investment "concentrations" (although they have vaguely cited OCC regulations as being the source of their botheredness, rather than the Prudent Investor Rule law per se. But I've never been able to pin them down on exactly where they are getting their "concentration" definitions so that I can go read it myself.). E.g. According to them, the trust portfolio can't hold more than 10% of its assets in any one actively managed fund. They used to say no more than 25% in any one broadly diversified index fund (e.g. Total Stock Market Index or S&P 500 Index), although they seem to have backed off on that recently. (Relating this to the above discussion: this corporate trustee would say that the law doesn't allow more than 10% of portfolio in something like Vanguard Wellesley. Although they do get kind of slippery/vague when you try to pin them down on exactly which law says that.)

But then the Uniform Investor Act led to trustees often being conflicted between the Prudent Investor Rule's focus on total return and their "income goes to income beneficiary" duties, so most states have, I think, in the late 1990s to early 2000s adopted Power to Adjust and associated Unitrust laws that grant some extra options and set parameters on how trustees can balance between the two requirements.

State versions of the Uniform Principal and Income Act govern how various expenses and cash flows (e.g. short/long term capital gains) are allocated to principal and income.

Yet other state laws (Surrogate Court law in the state where the trust I am familiar with is located) set yet more parameters on what trustees can or can not do, e.g. how much their fee can be and how the fee is allocated between principal and income.

Again, I am not a lawyer. Gill is/was. Just some things I think I have pieced together from dealing with the corporate trustee/investment manager over the years. My take-away is that many of the topics that are being debated above have largely already been addressed by trust & estate law in many/most states.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 12:04 pm

VaR wrote:
Tue Jun 12, 2018 11:19 am
ibhhvc wrote:
Tue Jun 12, 2018 5:57 am
I finally got to take a deeper look into the trust document. It specifies that "all of the net income" be distributed to the fourth party. After they pass, the trustee shall distribute the "remaining trust property" to the first three parties pro rata.

The trustee is also tasked to "determine in a fair, equitable, and practical manner what will be credited, charged, and apportioned between principal and income". That's about all the instruction there is.
I can't help but think that there is some phrase in the trust document that explains the intent of the trust and thus the duty of the trustees. Not the mechanics as above but the intent.

For instance, I'm not unlikely to have a trust created for after my death where the income goes to my wife and the principal is remaindered to her kids. But the primary goal of this is steady life income to her and I won't care much if there is a remainder for the kids. She can always spend less than the income and remainder the rest of the estate to them. They key aspect is that the assets are properly managed for a life income.

The trust intent might be different if I were unmarried and leaving the income to my sister and the remainder to her kids and she didn't really need the money.
Exactly so, which is why an otherwise impeccable investment such as Wellesley paying only 3% would impoverish your wife and usually transfer great wealth to the kids, the opposite of what was intended. The real heart of this problem is that setting the withdrawals for income at the amount of dividend paid is a nonsensical way to manage this affair though many people seem to think it is the appropriate prescription, including apparently a lot of trust lawyers. A better process would have been to appoint a disinterested trustee with discretion to support the needs of the wife independent of blathering about income and principal.

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Pajamas
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Re: Investing when someone else gets all dividends

Post by Pajamas » Tue Jun 12, 2018 12:13 pm

The reason this situation seems like something out of a 19th century novel is that this sort of trust originated in England, at least to my understanding. Traditionally the investments were government bonds (Consuls) paying a fixed rate of interest. The bonds were considered very safe and because the currency was based on precious metals, inflation wasn't so much of an issue and so such a trust would provide a reliable income indefinitely. Of course the modern context is different and the questions here reflect that.

I can't help but wonder how the holdings of the trust were invested by the creator of the trust and if that might be something to consider and possibly a way to defend the current investment choices if they reflect that.

bradpevans
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Re: Investing when someone else gets all dividends

Post by bradpevans » Tue Jun 12, 2018 12:32 pm

Ignoring the *uncertainty* in the returns, any portfolio choice (i.e. asset allocation) has implications for both the first recipient and the others upon passing.

One can argue that total return = growth + dividends, but that's not the way it was written up.
It *may* have been written that way exactly to avoid making "when to sell" decisions.

If I'm the (greedy?) first recipient i want a tilt to dividends, and tilt away otherwise. Sure lots of people on THIS forum say 2% / S&P, but i'm quite sure the document was constructed without this forum (or S&P Index) in mind.

I think you can argue lots of reasonable options, but any and all of them have implications for both sets of recipients.

ibhhvc
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Re: Investing when someone else gets all dividends

Post by ibhhvc » Tue Jun 12, 2018 12:35 pm

CnC wrote:
Tue Jun 12, 2018 11:17 am
Take into account a man with children remarries. He wants to leave everything he has to his children.

But, he feels an obligation to take care of his second wife so he is going to give her the dividends until she dies.

I'm fairly certain this is what the situation was. He wants his children to control the money since it will be theirs.
They probably kind of like the widow and don't want to completely hurt her, but also don't want an anchor around their inheritance.
This is exactly right.
ZZZZBest wrote:
Tue Jun 12, 2018 10:28 am
dbr wrote:
Mon Jun 11, 2018 6:45 pm
Who knows what the grantor wanted?
Would it be reasonable for the trustees to invest similarly to how the Grantor invested?
If it’s knowable at this juncture.
It might give some insight to the Grantor’s expectation for ‘income’ if they had invested themselves in 100% high dividend stocks vs say 80% Berkshire Hathaway + 20% 1 year CDs.
The rates of return for any given asset type will be different yesterday vs tomorrow, but philosophically...
The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?

bradpevans
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Re: Investing when someone else gets all dividends

Post by bradpevans » Tue Jun 12, 2018 12:43 pm

ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm
CnC wrote:
Tue Jun 12, 2018 11:17 am
Take into account a man with children remarries. He wants to leave everything he has to his children.

But, he feels an obligation to take care of his second wife so he is going to give her the dividends until she dies.

I'm fairly certain this is what the situation was. He wants his children to control the money since it will be theirs.
They probably kind of like the widow and don't want to completely hurt her, but also don't want an anchor around their inheritance.
This is exactly right.


The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
This seems wise and in-line with the original wishes. You might, if you felt comfortable, set up the Asset Allocation more in line with both wishes (near term and short terms) and then set up a 4.45 Withdraw rate

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 12:59 pm

ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm

The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
Well, that gives you something quantitative to work with in terms of inferring the assumptions of the grantor.

If you were to look through the list of low cost Vanguard funds that equal or exceed that yield you would find Long Term Corporate Bond and High Yield Corporate Bond as the viable choices. I doubt concentrating in that asset class would be considered practical and responsible.

Maybe someone can come up with some suggestions.

VaR
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Re: Investing when someone else gets all dividends

Post by VaR » Tue Jun 12, 2018 1:24 pm

ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm
The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
How did the original portfolio have an average dividend yield of 4.45%? Was this more than a decade ago? (I just want to make sure you're not counting capital gains distributions in dividend yield)

The Vanguard High Dividend Yield Index Fund/ETF currently has a dividend yield of 3.05%. The Vanguard Intermediate-Term Corporate Bond Index Fund has an SEC yield of 4.07%. Under the assumption that the original 4.45% yield was a while back, a combination of the two would result in a yield of 3.3% - 3.7%. The Vanguard International High Dividend Yield Fund has a yield of 3.38%.

You could probably "juice up" the yield by adding the Vanguard High Yield Corporate (bond) Fund with an SEC yield of 5.38%, but obviously you can't allocate too much of it due to suitability concerns.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 1:30 pm

Exactly, and thirty years ago or something like that I had ten year CDs paying 10% and in 1982 the Vanguard High Yield Bond Fund was paying something like 15%. It isn't that long ago a 5% CD was readily available. Good point.

ibhhvc
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Re: Investing when someone else gets all dividends

Post by ibhhvc » Tue Jun 12, 2018 1:41 pm

dbr wrote:
Tue Jun 12, 2018 12:59 pm
ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm

The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
Well, that gives you something quantitative to work with in terms of inferring the assumptions of the grantor.

If you were to look through the list of low cost Vanguard funds that equal or exceed that yield you would find Long Term Corporate Bond and High Yield Corporate Bond as the viable choices. I doubt concentrating in that asset class would be considered practical and responsible.

Maybe someone can come up with some suggestions.
The issue is that, as far as I can tell, the grantor was not aware of the fees. I think he asked his financial advisor for a portfolio with a higher dividend yield. I don't know if he was ever allowed to make the choice to pay almost 2% in fees to get the 4.5% returns. So it's hard to infer what he would have done with all the information.

ibhhvc
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Re: Investing when someone else gets all dividends

Post by ibhhvc » Tue Jun 12, 2018 1:43 pm

VaR wrote:
Tue Jun 12, 2018 1:24 pm
ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm
The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
How did the original portfolio have an average dividend yield of 4.45%? Was this more than a decade ago? (I just want to make sure you're not counting capital gains distributions in dividend yield)

The Vanguard High Dividend Yield Index Fund/ETF currently has a dividend yield of 3.05%. The Vanguard Intermediate-Term Corporate Bond Index Fund has an SEC yield of 4.07%. Under the assumption that the original 4.45% yield was a while back, a combination of the two would result in a yield of 3.3% - 3.7%. The Vanguard International High Dividend Yield Fund has a yield of 3.38%.

You could probably "juice up" the yield by adding the Vanguard High Yield Corporate (bond) Fund with an SEC yield of 5.38%, but obviously you can't allocate too much of it due to suitability concerns.
No, this is as of March of this year. It's a mix of investment trusts and close ended mutual funds. Very far from bogleheads standards.

Here are all the holdings:

Image

There are also the following UITs from First Trust (with expense ratio):

FGSBEX 1.291
FPNCMX 1.595
FALBEX 1.73
FRNUTX 0.482
FRNUTX 0.218
Last edited by ibhhvc on Tue Jun 12, 2018 2:09 pm, edited 1 time in total.

VaR
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Re: Investing when someone else gets all dividends

Post by VaR » Tue Jun 12, 2018 1:57 pm

ibhhvc wrote:
Tue Jun 12, 2018 1:43 pm
No, this is as of March of this year. It's a mix of investment trusts and close ended mutual funds. Very far from bogleheads standards.
Interesting. That's a remarkably high yield and I'd be interested to know how they achieved it.

How long has this trust been going? And do you know how much appreciation the assets have seen during this time? Is there any way you'd see fit to post the investment trusts and funds? That will reveal the implied risk tolerance the grantor might have found acceptable. [just saw your edit with the holdings]

Anyway, this information makes me agree with the poster who said that knowing the investments the grantor picked would help us infer intent. I'd infer that the grantor wanted to maximize income while preserving capital and that the income beneficiary probably does have some income expectation based on the initial portfolio set up by the grantor.

VaR
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Re: Investing when someone else gets all dividends

Post by VaR » Tue Jun 12, 2018 2:04 pm

I'm going to go through a few of the holdings to analyze what they are. People can post their results and I will try to summarize here.

symbol - yield - name - my understanding of the product
GGM - 10.13% - Guggenheim Credit Allocation fund - junk bonds and bank loans with some ABS
TWO - 12.48% - Two Harbors Investment Corp - Residential Hybrid Mortgage REIT
STWD - 8.64% - Starwood Properties Trust - hybrid REIT
FSD - 6.42% - First Trust High Income Long/short Fund - leveraged high yield bond hedge fund; 20% short treasurys
Last edited by VaR on Tue Jun 12, 2018 2:31 pm, edited 4 times in total.

ibhhvc
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Re: Investing when someone else gets all dividends

Post by ibhhvc » Tue Jun 12, 2018 2:06 pm

VaR wrote:
Tue Jun 12, 2018 1:57 pm
Interesting. That's a remarkably high yield and I'd be interested to know how they achieved it.
I think this reinforces something I've seen mentioned elsewhere on the forum. It's not that actively managed funds can't beat the market (or in this case beat the dividends of the market). It's that they can't beat the market after fees. You take your 4.43%, subtract your 1.92% and you get a mediocre 2.51% return.

Except in the case of the trust, the remainder beneficiaries pay the fees and the current beneficiary gets the income. And the fund managers get paid too of course.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 2:14 pm

ibhhvc wrote:
Tue Jun 12, 2018 2:06 pm
VaR wrote:
Tue Jun 12, 2018 1:57 pm
Interesting. That's a remarkably high yield and I'd be interested to know how they achieved it.
I think this reinforces something I've seen mentioned elsewhere on the forum. It's not that actively managed funds can't beat the market (or in this case beat the dividends of the market). It's that they can't beat the market after fees. You take your 4.43%, subtract your 1.92% and you get a mediocre 2.51% return.

Except in the case of the trust, the remainder beneficiaries pay the fees and the current beneficiary gets the income. And the fund managers get paid too of course.
No, no, no, you are confusing yield and return. You would have to ask the advisor for a report on return, and that would have to be IRR to allow for transactions in the account.

FactualFran
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Re: Investing when someone else gets all dividends

Post by FactualFran » Tue Jun 12, 2018 2:28 pm

ibhhvc wrote:
Tue Jun 12, 2018 5:57 am
The trustee is also tasked to "determine in a fair, equitable, and practical manner what will be credited, charged, and apportioned between principal and income". That's about all the instruction there is.
It looks as if the trustee has some discretion about how to apportion the total distributions of a mutual fund in the trust (income plus capital gain) between principal and income of the trust. With a fund like the Vanguard Managed Payout fund, it may be fair, equitable, and practical to classify the monthly distributions of the fund as income and any additional distributions as principal.

ZZZZBest
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Re: Investing when someone else gets all dividends

Post by ZZZZBest » Tue Jun 12, 2018 2:29 pm

ibhhvc wrote:
Tue Jun 12, 2018 12:35 pm
The original portfolio was held with a FA. It contains over 80 holdings including 60 mutual funds with a total dividend yield of 4.45%. However, the fees for the mutual funds in the portfolio totaled 1.92%. It's hard to continue this strategy because the fees cut into the principal and don't seem to provide any upside. We could try to get similar dividends (4.45%) without the fees?
I would think of the fund fees as taking away from principal, and FA fees as taking away from income if AUM based.
Regardless, the market is what the market is, as far as dividends and interest.

I’m sticking with the 50/50 suggestion.
But use a dividend stock fund. Then you owners of principal tay taxes on distributed capital gains that must stay in the trust. At least that is my understanding of how it’ll work.
Then an intermediate duration corporate (non junk) bond fund.
And call it a day.

If the grantor wanted to ensure *all* needs of the first beneficiary were met vs ‘get the interest and dividends,’ then we must ask why the grantor did not write a trust to allow principal distributions.

The imperfect analogy in my mind is if it were rental property and the first beneficiary gets ‘rent minus expenses’. The rent is gonna be what the market says it will be. And you (Boglehead Trustee) are now going to save everyone a ton of expenses.

But I’m a trustee newbie myself.

ZZZZBest
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Re: Investing when someone else gets all dividends

Post by ZZZZBest » Tue Jun 12, 2018 2:38 pm

ibhhvc wrote:
Tue Jun 12, 2018 1:43 pm
Very far from bogleheads standards.

Here are all the holdings.
Youch.
I thought my case of 40+ assets was a handful to Boglehead-ize.
Sincerely, best wishes.

VaR
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Re: Investing when someone else gets all dividends

Post by VaR » Tue Jun 12, 2018 4:29 pm

One thing about REIT funds is that it is hard to know beforehand how much of their "yield" will be capital gains distribution vs return of capital vs income.

Two Harbors example: I found an explanation of their 2017 dividends and it looks like 60% of their dividend is actually a return of capital. So of their 12.48% dividend, So their true income dividend was about 5%.
http://investor.twoharborsinvestment.co ... nformation

So I wonder what the actual distribute of income from the trust was in 2017? That the 4.43% forward estimate is an upper bound and needs to be adjusted down for actual income distributions vs return-of-capital. That said, the net income of the trust is juiced up with junk bonds (and even leveraged junk bonds), so it will be hard to stomach replicating it.

Even so, I think its possible to closely follow the original portfolio with low cost mutual funds and ETFs. For example, if we blend:
25% Vanguard High Dividend Yield Index Fund - 2.98% SEC yield
25% Vanguard International High Dividend Yield Index Fund - 4.16% dividend yield
25% Vanguard High Yield Corporate (bond) Fund - 5.69% SEC yield
25% Vanguard Long-Term Corporate Bond Fund - 4.66% SEC yield

We end up with a portfolio yielding 4.37%.

Would I advocate such a portfolio? No, but it is a portfolio that may replicate the risks and yield of the original trust portfolio but have much lower costs. This will probably result in a higher portfolio value after 10-15 years.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 5:06 pm

VaR wrote:
Tue Jun 12, 2018 4:29 pm
One thing about REIT funds is that it is hard to know beforehand how much of their "yield" will be capital gains distribution vs return of capital vs income.

Two Harbors example: I found an explanation of their 2017 dividends and it looks like 60% of their dividend is actually a return of capital. So of their 12.48% dividend, So their true income dividend was about 5%.
http://investor.twoharborsinvestment.co ... nformation

So I wonder what the actual distribute of income from the trust was in 2017? That the 4.43% forward estimate is an upper bound and needs to be adjusted down for actual income distributions vs return-of-capital. That said, the net income of the trust is juiced up with junk bonds (and even leveraged junk bonds), so it will be hard to stomach replicating it.

Even so, I think its possible to closely follow the original portfolio with low cost mutual funds and ETFs. For example, if we blend:
25% Vanguard High Dividend Yield Index Fund - 2.98% SEC yield
25% Vanguard International High Dividend Yield Index Fund - 4.16% dividend yield
25% Vanguard High Yield Corporate (bond) Fund - 5.69% SEC yield
25% Vanguard Long-Term Corporate Bond Fund - 4.66% SEC yield

We end up with a portfolio yielding 4.37%.

Would I advocate such a portfolio? No, but it is a portfolio that may replicate the risks and yield of the original trust portfolio but have much lower costs. This will probably result in a higher portfolio value after 10-15 years.
I would say that is the kind of thing one is cornered into to meet the constraints of this sort of situation. It is probably a good illustration of why income = dividends leads to bad thinking. There still needs to be an analysis of what the distribution of end point wealth of such a portfolio will be with those yields withdrawn along the way. Now that the income beneficiary is not cheated of their due, can we say the remaindermen can count on what they hope is promised to them. If you use FireCalc as a quick and dirty model, 50/50 asset allocation, long term corporate bonds, 15 year span, 4.37% withdrawal, inflation indexed, then the range of endpoint wealth in nominal dollars (I think FireCalc reports that result in nominal dollars) is a growth of $10,000 to between $5000 and $50,000, more descriptively a mean of $18,000 with a standard deviation of $11,000. In other words will the remaindermen recognize how volatile that asset allocation is? On the other hand, if the time period is extended to 30 years, then there is a 35% chance the portfolio will be exhausted before the end and the income will stop and the remaindermen will get nothing. How long did we say this trust would last? These sorts of estimates being, as said, rough and ready and subject to uncertainty.

msk
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Re: Investing when someone else gets all dividends

Post by msk » Tue Jun 12, 2018 5:35 pm

If the future will imitate history over the past 50 years, then a 100% stocks portfolio can pay out 5% of portfolio value (including dividends) annually and the remaining portfolio should keep up with inflation forever. I suspect that the person who had set up the trust was thinking of more like a bunch of RE rental units. They generate a net income yet decline only slowly in value real term. The 5% WR has the disadvantage of jumping up and down with the market, so perhaps all 4 beneficiaries could agree to an initial 4%, rising to 5% when the market tanks. The fluctuations to the annual payout will thereby be smoothed out. As long as the WR does not exceed 5% the principal stands an excellent chance of being preserved in real terms. Bringing bonds into it, for something that has to last more than 15 years is, IMHO, shortchanging all beneficiaries. Bad.

Enzo IX
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Re: Investing when someone else gets all dividends

Post by Enzo IX » Tue Jun 12, 2018 5:43 pm

How about using a flexible distribution plan that of the previous dividend rate or somewhere close there of. This would hopefully provide for the beneficiary's needs and also leave the trustees a legacy upon the death of the income recipient. On or about the first of the year the beginning balance of the portfolio is established and the distribution for the year is created by selling the appropriate amount of securities. The proceeds go into a money fund or an ultra short treasury fund and the money is distributed monthly or quarterly as deemed appropriate.

Funds used would be a 50/50 or 60/40 asset allocation of index funds. This should pass the fiduciary test if the situation were to get nasty as well I think honor the spirit of the originator of the trust's wishes.
Last edited by Enzo IX on Wed Jun 13, 2018 4:10 am, edited 1 time in total.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 5:52 pm

msk wrote:
Tue Jun 12, 2018 5:35 pm
If the future will imitate history over the past 50 years, then a 100% stocks portfolio can pay out 5% of portfolio value (including dividends) annually and the remaining portfolio should keep up with inflation forever. I suspect that the person who had set up the trust was thinking of more like a bunch of RE rental units. They generate a net income yet decline only slowly in value real term. The 5% WR has the disadvantage of jumping up and down with the market, so perhaps all 4 beneficiaries could agree to an initial 4%, rising to 5% when the market tanks. The fluctuations to the annual payout will thereby be smoothed out. As long as the WR does not exceed 5% the principal stands an excellent chance of being preserved in real terms. Bringing bonds into it, for something that has to last more than 15 years is, IMHO, shortchanging all beneficiaries. Bad.
Yes, but the dilemma we are discussing is that the income has to be the dividends not even including capital gains distributions or return of capital. So now the problem is to find a collection of stocks that are paying 5%. So, put it all in T, F, BP, RDS, HSBC, etc. The volatility would be very high. The endpoint wealth would average maybe a doubling of the money in 15 years, but the range of outcomes for $10,000 invested could be zero (due to the withdrawals) to $100,000 give or take a bunch.

dbr
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Re: Investing when someone else gets all dividends

Post by dbr » Tue Jun 12, 2018 5:57 pm

Enzo IX wrote:
Tue Jun 12, 2018 5:43 pm
How about using a flexible distribution rate that of the previous dividend rate or somewhere close there of. This would hopefully provide for the beneficiary's needs and also leave the trustees a legacy upon the death of the income recipient. On or about the first of the year the beginning balance of the portfolio is established and the distribution for the year is created by selling the appropriate amount of securities. The proceeds go into a money fund or an ultra short treasury fund and the money is distributed monthly or quarterly as deemed appropriate.

Funds used would be a 50/50 or 60/40 asset allocation of index funds. This should pass the fiduciary test if the situation were to get nasty as well I think honor the spirit of the originator of the trust's wishes.
The trust document specifies that dividends and interest (and presumably only dividends and interest) are to be distributed. If more than the dividends can be distributed then the trustees can manage the problem. As it stands the yield would have to be continually manipulated by changing the investments if the distributions are to be manipulated. Money in money fund can't be distributed because it is principal unless it is just a temporary accumulation of dividends.

Leesbro63
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Re: Investing when someone else gets all dividends

Post by Leesbro63 » Tue Jun 12, 2018 6:34 pm

Can’t all the beneficiaries (current income beneficiary and current trustees who are the future beneficiaries) agree, in writing, to something that amends the trust and allows for “total return investing”? I’m no lawyer, but if all of the parties agree, is this not legal/doable? Maybe the current income beneficiary agreed to a 5% payout in return for giving up the concept of “income from interest and dividends”.

Ben Mathew
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Re: Investing when someone else gets all dividends

Post by Ben Mathew » Tue Jun 12, 2018 6:54 pm

oldcomputerguy wrote:
Sun Jun 10, 2018 2:09 pm
ibhhvc wrote:
Sat Jun 09, 2018 7:38 am
Allows the principal in the account to grow without any dividend reinvestment.
How will principal grow without dividend reinvestment? I'm a bit confused by this requirement.
Through retained earnings and/or valuation changes.

Ben Mathew
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Re: Investing when someone else gets all dividends

Post by Ben Mathew » Tue Jun 12, 2018 8:48 pm

High income assets such as high dividend stocks or a high yield bonds will favor the fourth person entitled to the "income" portion. Conversely, low income assets will favor the three of you entitled to the "principal". It was not a good way to structure the estate, but given that's what you have to work with, you're left to figure out what's a fair balance between income and growth for all four of you. I'm not a lawyer and have no idea what the legal requirements in such a situation is. But from a fairness point of view, I think that creating a diversified portfolio whose principal can be expected ex ante to hold its value in real terms is fair. That means all ex ante expected real earnings go to the income recipient. The principal plus unexpected valuation changes stays with the three principal recipients.

You can achieve this easily by striking the right balance between stock and bond funds. The principal in stocks can be expected to go up in value in real terms (because dividends is usually less than earnings, i.e. retained earnings>0). The principal in bonds will go down in real value because the interest being paid out as income includes the compensation for expected inflation. For example, if the broadly diversified stock fund has 2% in retained earnings, and inflation is expected to be 2%, then a 50/50 stock-bond ratio (already suggested earlier) will have an expected real growth rate of principal of 0%. The 2% gain from retained earnings in stocks is cancelled out by the 2% loss from inflation in bonds. All expected real income is going to the income recipient.

Of course, because stocks are risky, the three principal recipients might find themselves with much more or much less than the original real principal of the portfolio. But it is a fair proposition ex-ante, and all parties will just have to agree to live with the gains or losses.

I really would not try to replicate the unusual, risky, and expensive portfolio currently in the trust, unless forced to do so to protect myself legally. A 50/50 or thereabouts stock/bond allocation using broadly diversified stock and bond funds, neither of which are tilted in any way towards or away from income, seems like a good way to go. That's my two cents, anyway. When it comes to what people consider "fair" though, it's a tough call. Hopefully, no one sues.

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