My Favorite Way to Generate High Cash Flow
Want to generate a high cash flow from your portfolio? Want the ability to set the income level to meet your needs? Today I’m going to share with you my favorite way to generate yield, income or cash flow from an investment. I like it because I’m in control of how much income I generate from the assets, I control the asset mix, and I’m diversified across all types of stocks and bonds not just dividend stocks. As a result I check all the boxes for a good investment and get my cash flow too!
Here are the steps we’ll be following today:
Step 1: Pick a Robo-Advisor the Supports Cash Flow
This strategy works extremely well with a robo-advisor because you can set it and forget it and the cash will flow directly into your bank account each month and you don’t even have to do a money transfer. However, it can also work with a free or discount brokerage but it won’t be as elegant or seamless. The Robo-Advisor will handle all the transactions for us; keep us on our target asset allocations and make everything run smoothly.
First select from the ever growing world of Robo-Advisors. You can read our review of Robo-Advisors here or read this thorough review over at Young and Thrifty. Pick a service that supports monthly withdrawals
For our purposes we’ll be using WealthSimple and a TFSA account. If you decide to follow this guide, and invest with WealthSimple, use this link so we both get $10,000 of assets managed free.
Step 2: Allocate Your Assets for Cash Flow
As you setup your account with WealthSimple you will be asked a series of questions like your age and investing time horizon to determine your risk tolerance and this determines the percentage of stocks and bonds you should own. They have science and research to backup their allocations but I personally find them a bit too conservative; luckily you can easily change the allocation to suit your needs. Refer to our asset allocation guide for our recommended percentages of stocks, bonds and gold. I’m currently 42 which means I set my assets to the 80% stock, 20% bonds.
After I set my allocation I make my first deposit and the capital gets allocated automatically to the set asset mix. Simple. No commissions. Automatic.
Even though I’ll be generating a nice healthy 8% income from this portfolio, I want to use a growth portfolio because I’m after total return. Total return means we are after the total return of the portfolio after capital appreciation, dividends paid, interest earned and fees paid out. We want our total return to be greater than the income we drive out of this portfolio. This way we can whip 4%, 6%, 8% from this year after year. In our next step you’ll see how we configure this high cash flow investment. We’ll also show you how we protect the asset base so we can have our cake and eat it too!
Step 3: Set Your Cash Flow Level
Now we’re going to setup things up so we generate our high cash flow, and like I said above we’ll be targeting a nice juicy 8%. As you’ll see, we can set this to whatever percent we want. However we don’t recommend going above 8% as even this level is difficult for the assets to maintain year after year.
Quote
First, take your capital base. In the example we’re using today I have $10,647.12 ready for investing. I take this and muliply it by 8% then divide it by 12 to determine how much money we want this portfolio to deposit into our bank account each month.
- 10,647.12 X 0.08 / 12 = $70.98
Go into WealthSimple and setup the withdrawal. (This must be done on the desktop web version).
Hit Submit and we have a monthly cashflow of $70.98 coming in from our TFSA!
One thing I love about WealthSimple are the future projections.
I can keep taking my 8% yield from this account for 21 years. That’s incredible. This assumes a 5.07% annual return net of fees which is very reasonable for an 80/20 growth portfolio. Now let’s see what we can do to further protect this because sometimes we value capital preservation along with our income.
Step 4: Protect the Assets
Annual Cash Flow Adjustment
The first thing we can do to protect the assets, and stop eroding away the asset base, is to revisit the withdrawal rate annually to ensure we are always withdrawing 8% from the remaining capital base. So if the account balance rises we will draw more, but if it lowers we will draw less. This will help during down years to stop accelerating the eroding effects of such a high withdrawal rate. Imagine the portfolio returns -5% and you took out 8%. Now the asset base is at -13% from the year prior. So adjust the withdrawal rate each year to match the new capital base value, not the old one.
Lower Initial Cash Flow Rate
The next thing we can do is to lower the yield to less than or equal to 5.07% – – which is the projected annual return of the asset base. What if we went with 4%? Let’s re-run our calculations and set our withdrawal rate to $35.50 a month. What will our projection look like?
We will not run out of money over the next 23 years – in fact it should grow by nearly 50%. Keep in mind we are truly taking out the money and spending it each month. We are not taking it out and then just re-investing it back in. If your plan is to reinvest the cash flow, then just turn off the withdrawal and allow the money to ride and compound naturally.
Protecting the Assets Summary
- If you’re fine with the 21 year draw down rate then leave things as they are and enjoy the juicy 8%
- Consider adjusting the 8% each year against the remaining capital base to slow the erosion.
- Lower the yield to a maximum of the projected annual returns – in this case we used 4% and it worked like magic.
Comparison vs. Dividend Funds
This is the first and most natural argument – that we should invest in dividend funds or better yet covered call dividend funds. They offer great returns and the capital base will grow over time. There is a key difference here: In our method we are taking the money and spending it. We are not reinvesting it. The performance numbers and metrics for all dividend, bond, and covered call ETF funds all assume immediate reinvestment of the dividends. They are showing total returns after reinvestment not returns after dividends paid out and spent by the fund holders.
Consider the following funds performance including reinvestment (total return) against what those returns would be if we had subtracted the current yield each year.
- ZWU – BMO Covered Call Utilities ETF – collection of Canadian utility stocks against which the manager sells covered call options to boost the income generated
- CDZ – iShares Canadian Dividend Aristocrats – established Canadian companies that increased ordinary cash dividends every year for at least five consecutive years
- ZDV – BMO Canadian Dividend ETF – a yield weighted portfolio of Canadian dividend paying stocks. The fund considers the three year dividend growth rate, yield, and payout ratio to invest in Canadian equities.
- WealthSimple Growth Portfolio – Diversified growth oriented portfolio of equities and bonds automatically managed for you
If you had invested $10,000 in each of these funds back in 2015 and consumed the dividend each year how much would you have left as of August 31, 2020?
Summary
Hopefully we’ve given you some excellent ideas of how to generate a high cash flow stream. You can do it using a well diversified portfolio of all types of stocks – not just dividend stocks, and bonds, and have the money deposited directly into your bank account month after month.
We’ve shown you how to project the value of your account into the future to see how long your income stream will last and learn the relationship between cash flow rate, time horizon and capital base. There is a nice sweet spot where you can confidently draw on the assets while they still maintain their value and maybe even grow a little.
Lastly, I hope this shows you a pathway and method out of the rat race and towards financial freedom. Set some goals and see your asset base grow to the point where you can confidently generate the income stream you will need to stop working for money.
