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Using Weighted Averages

I examined using weighted averages on the Expanded Allocator. They almost always work well for the first 15 years. Sometimes, weighted averages work well for more than 30 years.

Background

ElLobo, a regular poster on Morningstar’s Income & Dividend Investing discussion board, has suggested using weighted averages with my Income Stream Allocator calculations. I examined this. I used my latest version, the Expanded Allocator.

NOTE: ElLobo wrote the most recent Letter to the Editor, which formalizes income stream investing.

Comparisons

I compared sets of three investments. I compared an allocation of 33%-34%-33% with an allocation of 0%-100%-0%. I determined how much the income streams differed, both in dollars and as percentages.

I examined the following combinations:

Condition A

Investment 1: 6% initial yield with 10% per year growth.
Investment 2: 8% initial yield with 8% per year growth.
Investment 3: 10% initial yield with 6% per year growth.

Allocation: 33%-34%-33% versus 0%-100%-0%.

Outcome:

All balances within 2% until year 36.

Condition B

Investment 1: 6% initial yield with 12% per year growth.
Investment 2: 8% initial yield with 8% per year growth.
Investment 3: 10% initial yield with 4% per year growth.

Allocation: 33%-34%-33% versus 0%-100%-0%.

Outcome:

All balances within 2% until year 19.

Condition C

Investment 1: 6% initial yield with 8% per year growth.
Investment 2: 8% initial yield with 8% per year growth.
Investment 3: 10% initial yield with 8% per year growth.

Allocation: 33%-34%-33% versus 0%-100%-0%.

Outcome:

All balances identical.

Condition D

Investment 1: 8% initial yield with 6% per year growth.
Investment 2: 8% initial yield with 8% per year growth.
Investment 3: 8% initial yield with 10% per year growth.

Allocation: 33%-34%-33% versus 0%-100%-0%.

All balances within 2% until year 16.

Conclusions

Using weighted averages works well for the first fifteen or sixteen years. It works especially well when the dividend yield plus growth rates are similar and when the growth rates are very close together.

Yahoo Briefcase

You can download my Using Weighted Averages spreadsheet from my Yahoo Briefcase. It is in the Allocators folder.

Yahoo Briefcase

Have fun.

John Walter Russell
April 8, 2007