Dividend Stock Portfolio Provide Higher SWR?

[FIREd]

And a few more:

Vanguard Equity Income (VEIPX), which I use as my "dividend portfolio": the 12-month trailing dividend dropped 35% from Q3 2008 to Q2 2010. The dividend is still dropping. Current yield is around 2.8%. Apparently the fund managers could use some advice from forum members.

Vanguard REIT Index: the 12-month trailing dividend dropped 50% from Q1 2008 to Q1 2010 with a slight rebound in the past quarter.

Overall, my passive income has dropped about 25% since the beginning of the crisis (due to dividend cuts but also a surge in the US dollar) and, for the most part, it has yet to recover.

 

[Ed_The_Gypsy]

Wasn't BP consider one of those "solid" dividend stocks?
TJ

And will be again.

 

[Marc1962]

[...] the total-return approach to spending is identical to the income approach for investors whose portfolios generate enough cash flow to meet their spending needs.

The context of this statement from the paper is portfolios with typical dividend yields. Elsewhere it makes the point that companies with high dividend yields offer lower total returns even before considering the tax disadvantages of dividends.

 

[kyounge1956]

It's all explained in this: https://institutional.vanguard.com/iip/pdf/WP_TotalRet.pdf
Among other reasons to use a total return approach instead of a dividend approach: LT capital gains are taxed less than dividends.

Unless of course we're talking about an IRA, in which case it makes no difference. I finally realize why this is so seldom pointed out...it's because those of us who have all our retirement savings in tax-advantaged accounts are outnumbered nine to one! (according to two recent polls on that topic)

I've seen the Total Return article somewhere before—I don't recall whether it was here or Bogleheads. ISTM that the higher withdrawal rate possible with the Total Return approach is dependent on having capital gains to tap, in addition to the dividends and interest. This seems to me a rash assumption to make, especially in view of the market's behavior over the last few years. What if the market just fluctuates a little each side of Dow 10200 for the next few years, like it has been for the last few months? I also have some concern about what is likely to happen when umpteen million baby boomers start to sell stocks as we draw down our portfolios. The next age cohort after us, who will then be in their peak earning & investing years, is fewer in numbers. It's been a long time since I took Econ 101, but isn't more sellers than buyers a formula for falling prices?

A while ago, I looked up serial correlations in SBBI. I'm going by memory, but the serial correlation of dividends was somewhere in the neighborhood of 0.9, compared to something like 0.3 serial correlation for capital gains. If this means what I think it does, there is a very high probability that a stock's dividend this year will be similar to the same stock's dividend last year. That's no guarantee the dividends will increase enough to keep pace with inflation, or for that matter that they will increase at all. But it sounds better to me than counting on capital gains where there is essentially no relation at all between one year's gains and the next. I am thinking seriously about taking an income approach when it comes time for me to start drawing on my portfolio.

 

[jebmke]

Well lets look at some dividend portfolios.
Vanguard Dividend Appreciation ETF (VIG)
Q1 2009 distribution $.2706
Q2 2010 distribution $.25

Vanguard High Yield Dividend ETF (VYN)
Q1 2009 $.31
Q2 2010 $..273

iShare Dow Jones Dividend Index fund (DVY)
Q2 2008 $.631
Q2 2010 $.425

I am glad I went through this exercise cause now I don't feel so bad about my 10-12% in dividend income.

If you are earning 10-12% dividend yield you are taking a huge risk somewhere.

 

[LOL!]

Folks are writing here on this thread as if stock dividends are the only way to generate income. That's not true. Your bond funds generate income as well. The article writes about both bond and stock dividends.

If you are retired, early or otherwise, I think most of you will have some bonds to dial down your risk level. Those bonds will produce income. I have a pretty typical portfolio of stocks and bonds. My portfolio has a 3% yield, so if I wanted to have a 4% sustained withdrawal rate, I would only need to sell off 1% of my stock funds every year. (Hmmm, that's not a bad glide path for increasing my bond percentage and making the portfolio less risky over the years.)

Anyways, I have my bond funds in tax advantaged, so the bond income is tax-deferred and does not get taxed yearly. I don't want excessive-dividend paying stocks in my taxable because I would rather tax-defer the capital gains, but I do want all the dividends to be qualified.

As it is, I get plenty of dividend income without resorting to high-yield stuff.

 

[jebmke]

One of the problems with managing for yield is that it focuses your attention on something you can't control.

With a total return approach you are more likely to focus on things you can control such as duration, credit quality, asset allocation. I took a quick look at the last two years and found that my overall total holdings are down about 3% from this time, 2008. That includes some withdrawals.

If I were focusing on yield, I would be tempted to increase the duration on fixed or go for higher risk funds like high-yield corporate or municipal debt. Instead, I am shortening maturities and have shifted some funds that had a mix of investment-grade and high-yield to all investment grade.

 

[clifp]

If you are earning 10-12% dividend yield you are taking a huge risk somewhere.

Sorry I meant a 10-12% drop in dividend income from 2008 to now.

 

[samclem]

My goal would be to have about 30 to 40 companies at the most, to be well diversified.

While "well diversified" is a subjective term, I'd not feel comfortable that I was well diversified with any 40 stock portfolio.

Here's an interesting paper from William Bernstein. In part:

To be blunt, if you think that you can do an adequate job of minimizing portfolio risk with 15 or 30 stocks, then you are imperiling your financial future and the future of those who depend on you. The reason is simple: There are critically important dimensions of portfolio risk beyond standard deviation. The most important is so-called Terminal Wealth Dispersion (TWD). In other words, it is quite possible (in fact, as we shall soon see, quite easy) to put together a 15-stock or 30-stock portfolio with a very low SD, but whose lousy returns will put you in the poorhouse.

. . .

The reason is simple: a grossly disproportionate fraction of the total return came from a very few "superstocks" like Dell Computer, which increased in value over 550 times. If you didn’t have one of the half-dozen or so of these in your portfolio, then you badly lagged the market.

So, yes, Virginia, you can eliminate nonsytematic portfolio risk, as defined by Modern Portfolio Theory, with a relatively few stocks. It’s just that nonsystematic risk is only a small part of the puzzle. Fifteen stocks is not enough. Thirty is not enough. Even 200 is not enough. The only way to truly minimize the risks of stock ownership is by owning the whole market.

It would be great to see an update on his stats that covered the recent "unpleasantness" in the market.

One other factor that makes it hard for a dividend investor to develop a well diversified portfolio with any number of stocks is the sector concentrations that come with dividend investing. Such an investor is unlikely to own Dell or any of the "superstocks" which, at various times, have contributed such a large amount to the overall performance of the broader market. Certainly there will be periods when the returns from a few growth stocks won't be so important, but I think it's probably unwise to disregard their importance over the long haul.

I think there's good reason to believe the next 50 years will be more turbulent than the last 50, particularly in the US. Under such circumstances, "promises" of all kinds, including dividend payments, are less credible.

I would hope that having some kind of buffer (bucket system) would help in surviving any down trend in dividend cuts. Something like 3 yrs annual expenses in cash holdings and the dividends replenishing the bucket.

Agreed.

 

[clifp]

Folks are writing here on this thread as if stock dividends are the only way to generate income. That's not true. Your bond funds generate income as well. The article writes about both bond and stock dividends.

If you are retired, early or otherwise, I think most of you will have some bonds to dial down your risk level. Those bonds will produce income. I have a pretty typical portfolio of stocks and bonds. My portfolio has a 3% yield, so if I wanted to have a 4% sustained withdrawal rate, I would only need to sell off 1% of my stock funds every year. (Hmmm, that's not a bad glide path for increasing my bond percentage and making the portfolio less risky over the years.)

Anyways, I have my bond funds in tax advantaged, so the bond income is tax-deferred and does not get taxed yearly. I don't want excessive-dividend paying stocks in my taxable because I would rather tax-defer the capital gains, but I do want all the dividends to be qualified.

As it is, I get plenty of dividend income without resorting to high-yield stuff.

Overall my portfolio income (bonds and stocks) is only 3.1% so not much different. However with the Total Stock Market yielding 1.68% and total bond market at 2.52% A 50/50 portfolio only yields 2.1% so you must have some above average yields in the mix somewhere. So to get to a 4% you now need to sell of 2% of your stock portfolio a year. This is probably fine at 65, not so fine at 55 or earlier.

The tough thing now days is that neither bonds nor stock generate any where close to the 4% magic number.
I agree with you about Asset location, and I'll confess I do a pretty poor job since I have GNMA bonds in my taxable account and non-dividend paying stocks (primarily Berkshire) in my IRAs. However, if rejiggered my portfolio, than more likely than not I'd have to start a 72(t) in a few years which would result in taxable income anyhow.

 

[LOL!]

So to get to a 4% you now need to sell of 2% of your stock portfolio a year.

Remember it is a total return approach, so one can sell either stocks or bonds or some of each every year if needed. One does not need to sell only stocks. Or hunker down and spend less.

Also my equities have a value tilt which tends to raise the yield a little bit.

 

[MichaelB]

What matters is total return. And yes, dividend tax is more costly that capital gain tax.

However, when expected returns are below the long term average and dividends represent a substantial percentage of that expected total return, then dividend stocks offer a greater likelihood that the total return will indeed be achieved.

In addition, even with the threat that dividends can fall, there should be less volatility in a well diversified dividend portfolio compared with a total market portfolio when the yield as a % of total expected return is high.

Dividend payouts are also probably the best way to pay shareholders in well run companies that are mature and have limited growth potential.

Despite off the above, one ETF company – WisdomeTree – has been unable to make it work despite counting on the best academic credentials. This is a theory that sounds solid but is hard to make work.

It is imperative to analyze carefully, and even so, choosing a subset of total market stocks carries a risk of underperformance and portfolio concentration.

I like dividends, but not to excess. I would allocate the bulk of my portfolio to dividend income, however, only when the average yield of the entire market were close to my withdrawal rate. Anything else is too risky. In the meantime I have about 10% of my equity allocation in individual dividend stocks but do have a substantial part of my remaining equity allocation in funds that choose companies with growing dividends or other indications of strong balance sheets.

 

[Onward]

Despite off the above, one ETF company – WisdomeTree – has been unable to make it work despite counting on the best academic credentials.

Here's an article that discusses the Wisdom Tree LargeCap Dividend Fund, among other things:

Beware of Professors Bearing ETFs - WSJ.com

For example, WisdomTree Investments Inc. ... enjoyed great fanfare in 2006 when it launched a roster of ETFs that emphasized dividend-paying stocks, which Prof. Siegel argued were the key to beating the market in the long run.

Yet WisdomTree LargeCap Dividend Fund has posted negative average annual returns of 8% over the past three years, compared with 6.7% declines for the SPDR ETF, which tracks the Standard & Poor's 500-stock index

 

[jebmke]

I would hope that having some kind of buffer (bucket system) would help in surviving any down trend in dividend cuts. Something like 3 yrs annual expenses in cash holdings and the dividends replenishing the bucket.

The problem with this is that you tie up assets in an investment that has extremely low/zero expected return. Over the last 12 months my bonds (mix of treasury and investment grade) have returned about 8-9%. Even if I took a 5% hit on NAV from rising interest rates I'd still be ahead of cash by 3-4% over the last year. Even something as low risk as Limited Term Tax Exempt Bonds have returned 4.5% -- I'm guessing cash has been maybe a half percent?

 

[jIMOh]

I have looked into dividend sponsored retirement. I have started a few threads here and know it is quite possible.

http://www.early-retirement.org/forums/f28/dividend-investing-do-you-get-a-3-yield-37716.html

As I looked into it further- the people which get a 4% yield (current) did not buy those companies when they yielded 4%. They bought them when they yielded less (2%) and by reinvesting dividends and accumulating shares and market performance their yields and payout was higher.


If I were to advise someone how to do this, they would need a 5-10 year time horizon... to verify payout was working AND to attempt to buy companies at a good part of their business cycle. I would not want to see someone w*rk, accumulate share value in mutual funds, then sell those mutual funds for stocks which pay dividends, then retire the next month. Too much risk which takes present market performance into account for a retirement decision which needs to last 30-50 years.

If someone had a 10 year timeframe, I would look for dividend payers which totaled about 50-75 stocks. Trying to stay diversified while also trying to have a solid portfolio, and a portfolio which focused on payout.

I would own 10-20 large companies which paid a dividend. Companies like Microsoft, PG, and GE come to mind (I have not looked at these companies stock pages in years, but last I checked, all paid a dividend).

I would get some preferred stocks and REITs to kick in some high yield too- probably 2-10 different holdings.

I would also look for 2-4 large companies which do not pay dividends but are sitting on a high amount of cash. Oracle used to be in this category, but they recently started paying a dividend. Look for large companies which have cash on hand could add some stability if other companies drop their dividend and you still need a payout to maintain income.

I would add about 10 foreign companies which pay dividends as well (noting that tax treatment of foreign dividends might be different).

I would add a few sector plays (like utilities or financials) but turn these stocks over as I think other sectors (like health care or cyclicals) looked better.

I would add about 20-40 small and mid caps which paid dividends and hold a smaller (relative) position in each of these companies.

If I owned 10 large cap, I would want 20 small cap positions (for example) and each of the 20 small cap positions would be maybe 1/4 the size of the position in the large caps.

A follow up thread to the one I posted would be interesting, as I would be curious how late 2008 changed anyone's outlook on the 3% yield, and also curious if any new lessons learned came from recent market activity.

 

[LOL!]

^So all your "I would add ..." add up to: "I would buy a total stock market fund and a total international stock market fund, then some small-cap funds ...."

 

[teejayevans]

The problem with this is that you tie up assets in an investment that has extremely low/zero expected return. Over the last 12 months my bonds (mix of treasury and investment grade) have returned about 8-9%. Even if I took a 5% hit on NAV from rising interest rates I'd still be ahead of cash by 3-4% over the last year. Even something as low risk as Limited Term Tax Exempt Bonds have returned 4.5% -- I'm guessing cash has been maybe a half percent?

But the time horizon is short (3 yrs), so whether you get 1% or 4% isn't going to make that much difference, having a cash bucket prevents have to selling your investments when they're down (ie 3008-2009)
TJ

 

[LOL!]

^ Having bond investments (they don't have to be in a bucket) allows you to sell your bonds when they're up (ie 2008-2009) and even allows you to buy stock investments when they're down.

 

[jebmke]

^ Having bond investments (they don't have to be in a bucket) allows you to sell your bonds when they're up (ie 2008-2009) and even allows you to buy stock investments when they're down.

Exactly. Bonds were up big time during this period and cash sat there like a house plant.

 

[MichaelB]

I have looked into dividend sponsored retirement. I have started a few threads here and know it is quite possible.

http://www.early-retirement.org/forums/f28/dividend-investing-do-you-get-a-3-yield-37716.html

As I looked into it further- the people which get a 4% yield (current) did not buy those companies when they yielded 4%. They bought them when they yielded less (2%) and by reinvesting dividends and accumulating shares and market performance their yields and payout was higher.


If I were to advise someone how to do this, they would need a 5-10 year time horizon... to verify payout was working AND to attempt to buy companies at a good part of their business cycle. I would not want to see someone w*rk, accumulate share value in mutual funds, then sell those mutual funds for stocks which pay dividends, then retire the next month. Too much risk which takes present market performance into account for a retirement decision which needs to last 30-50 years.

If someone had a 10 year timeframe, I would look for dividend payers which totaled about 50-75 stocks. Trying to stay diversified while also trying to have a solid portfolio, and a portfolio which focused on payout.

I would own 10-20 large companies which paid a dividend. Companies like Microsoft, PG, and GE come to mind (I have not looked at these companies stock pages in years, but last I checked, all paid a dividend).

I would get some preferred stocks and REITs to kick in some high yield too- probably 2-10 different holdings.

I would also look for 2-4 large companies which do not pay dividends but are sitting on a high amount of cash. Oracle used to be in this category, but they recently started paying a dividend. Look for large companies which have cash on hand could add some stability if other companies drop their dividend and you still need a payout to maintain income.

I would add about 10 foreign companies which pay dividends as well (noting that tax treatment of foreign dividends might be different).

I would add a few sector plays (like utilities or financials) but turn these stocks over as I think other sectors (like health care or cyclicals) looked better.

I would add about 20-40 small and mid caps which paid dividends and hold a smaller (relative) position in each of these companies.

If I owned 10 large cap, I would want 20 small cap positions (for example) and each of the 20 small cap positions would be maybe 1/4 the size of the position in the large caps.

A follow up thread to the one I posted would be interesting, as I would be curious how late 2008 changed anyone's outlook on the 3% yield, and also curious if any new lessons learned came from recent market activity.

This is a good post and good advice - especially the part about taking time to build the portfolio vs reallocating from general equities into dividend payers.

A good book on this is The Ultimate Dividend Playbook by Morningstar The Ultimate Dividend Playbook

M* has pretty decent free tools for stock analysis, and Valueline has excellent data and tools, but is a bit pricey (50% discount for Fido customers).

 

[jebmke]

This is a good post and good advice - especially the part about taking time to build the portfolio vs reallocating from general equities into dividend payers.

A good book on this is The Ultimate Dividend Playbook by Morningstar The Ultimate Dividend Playbook

M* has pretty decent free tools for stock analysis, and Valueline has excellent data and tools, but is a bit pricey (50% discount for Fido customers).

Couple of comments. First, seems like a lot of work (not to mention trading costs). Second, I don't get the math implied by the following:

As I looked into it further- the people which get a 4% yield (current) did not buy those companies when they yielded 4%. They bought them when they yielded less (2%) and by reinvesting dividends and accumulating shares and market performance their yields and payout was higher.

Reinvestment is an independent decision to invest proceeds. That is purely a choice of investment.

Dividend yield is dividend yield. Market performance is growth. Mixing them up is ... hmm .... total return.

 

[avengerki]

Couple of comments. First, seems like a lot of work (not to mention trading costs). Second, I don't get the math implied by the following:

First while it may seem like a lot of work it really isn't. And if you are just doing buy and hold with dividends automatically reinvested you can keep trading costs minimal. Only if a stock or fund stops paying a dividend would you need to sell and rebalance.

Reinvestment is an independent decision to invest proceeds. That is purely a choice of investment.

Dividend yield is dividend yield. Market performance is growth. Mixing them up is ... hmm .... total return.

When bought its price to dividend were yielding 2% now its price to dividend is 4%. That or either he is referring to a virtual dividend yield of 4% which is from the amount originally invested compared to the current yield.

 

[jebmke]

When bought its price to dividend were yielding 2% now its price to dividend is 4%.

I suppose that is possible. Dividend would have to grow faster than the share price. I just have an aversion to dividends due to the taxes -- all my equity is in taxable accounts.

 

[avengerki]

I suppose that is possible. Dividend would have to grow faster than the share price. I just have an aversion to dividends due to the taxes -- all my equity is in taxable accounts.

Or the share price needs to fall. I was getting 2% dividends on some and when everything started crashing I went to about a 16% dividend on a couple now I am sitting around a 4% after they recovered. The majority of my dividend earners are in a roth ira so I don't worry about taxes on the dividends.

 

[grumpy]

In line with this discussion - Phillip Morris International (PM) today announced a 10% increase in its quarterly dividend to $.64 per share. This is a yield of 4.7% on Friday's closing price. I have owned Altria (MO) for many years - I bought in at $20 when there was a huge legal judgment against the company (later drastically reduced by the Supreme Court). It now trades at $23 after spinning off both Kraft (KFT) and PM in 2007 and 2008. MO's current yield is 5.5%