Hello darlings! It's been 9 months since the start of my blog and the Rainbow Portfolio, and I'm thrilled to share that I haven't missed a single contribution, which have totaled $2,250 year-to-date, hooray!
While there have been declines in the values of my non-GIC positions due to rising interest rates, higher interest rates have actually helped improve the overall yield of the portfolio. When interest rates rise, the prices of income bearing assets often decline in response, as investors seek higher returns to protect their investments from inflation. Because income bearing assets like preferred stocks pay investors fixed dividends, lower prices result in higher preferred stock yields.
Example:
McQueen's Fried Chicken 5.6% Series A Preferred stock has a redemption value of $25, and pays annual dividends of $1.4 per preferred share. However, due to interest rates rising to 5%, the price of McQueen's Series A Preferred have declined by 20%.
$1.4 ÷ $20 x 100 = 7%.
And this is why your girl lives for volatility. Most people stop buying when prices go down, because they're afraid that prices will keep declining. I, on the other hand, keep buying, because the lower the price paid for a preferred stock, the less risky it becomes thanks to higher prospective returns. An important caveat is to ensure that the associated company isn't at risk of bankruptcy, but I'll touch on that again later.
The first ever update for the Rainbow Portfolio was in January of this year, where its annual income yield sat at 5.35%. At this rate, for every $1,000 contributed to my TFSA, I would earn an additional $53.50 per year. With dividends for the next 12 months set to total $267.84 before contributions, and the book value of the portfolio now being $4,577.82 (broke $4K, yay!), the yield of the portfolio has notably increased to 5.85%.
$267.84 dividends ÷ by $4,577.82 book value x 100 = 5.85%.
Over the course of the next ten years, the $4,577.82 invested thus far will generate tax-free income of $2,678.4. If I reinvest the dividends I receive at an annual rate of 4.7%, I will end up with a 10-year value of $7,899.88, for total tax-free gains of $3,322.06.
The reason why I'm highlighting expected returns for the existing portfolio, is that year-to-date, the portfolio has suffered losses of $308.79. This has occurred due to declines in the portfolio's preferred stock holdings, as well as commissions paid on trades. However, while declines in the values of assets like preferred stocks can be painful, the fact that they generate consistent income tends to make them less risky than non-income generating assets, as the income earned can help offset losses. In the case of the Rainbow Portfolio, dividends of $134.56 year-to-date have helped reduce position declines and the impact of commissions.
Let's assume that interest rates stay elevated forever, and the portfolio's preferred shares remain depressed in response. This scenario is unlikely, as the 30-year average interest rate in Canada is 2%. Yet, even if rates remain elevated, my current holdings would still likely produce $2,678.4 in income over the next 10 years. And in the extremely unlikely scenario that the value of the portfolio halves, I would still turn a profit, especially if I reinvest the dividends.
Assuming no dividend reinvestment, my total annual compounded rate of return for 10 years in a world-is-ending-aah scenario would be about 1.1%. But, if I'm able to increase the amount of annual dividends by 4.7% per year by reinvesting them, then my annual compounded rate of return would increase to about 2.4%, which would be higher than historical inflation.
Take that, apocalypse!
Worst-case 10-year return scenario:
Market value of portfolio halves $4,332.15 ÷ 2 = $2,166.08
Adjusted market value of $2,166.08 + $2,678.4 in dividends = $4,844.48
Dividend reinvestment at 4.7% = $5,488.14
In contrast, if interest rates go lower, and the price of my preferred stocks trade closer to their redemption values of $25 each (the standard price that an issuing company can pay its investors to redeem a preferred stock), the market value of the portfolio would increase by upwards of $743.65. Adding dividend reinvestment at 4.7% per year, the 10-year value of the portfolio could potentially be worth $8,643.14 by 2033. This would represent an annual compounded rate of about 6.5%, for a total 10-year return of $4065.71, just from today's investments.
Economy-breaking scenario: I make money
Best-case scenario: I make a lot of money
What can I say? She's a win-win kind of babe.
So my loves, income helps reduce the risk of volatile assets over time, period. The more cash that is returned to an investor, the less likely they are to suffer a permanent capital loss. As such, the key long-term consideration when investing in preferred stocks is to ensure that their issuing companies are likely to a) never miss a preferred dividend payment, and to b) avoid bankruptcy.
For any reader who hasn't yet read my article on preferred stocks and would like to learn how to ensure the prior two points, you may access it here. Just know that preferred stocks are the most complicated type of fixed-income investment discussed on Rainbow Wealth, and are not necessary to ensure your future wellbeing. They are for people who are interested in learning how to generate higher overall long-term returns by investing in assets that they can independently understand and identify.
That said, as the Rainbow Portfolio scales, it will eventually contain the capital required to purchase bonds, which are the crème brûlée of income generating investments. It's at this point that the portfolio will likely phase out preferred stock holdings in favor these beautiful assets (likely starting in a few years), because they're awesome! The legal rights attached to senior debt make me giggle with glee. They are just so good guys. Don't pay my interest? Don't pay me back my principal when the debt comes due? Big mistake Mr. Wall Street cause I just seized your company. Oops! Sorry not sorry!
I've been dragging my feet on the bond article I've been writing, but it is coming!
To conclude this update, below outlines the current market value of the portfolio, and the portfolio's weightings. We're on our way to $5K!
And that's it! Happy pre-Halloween cuties!
Disclaimer
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