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Old 07-14-2007, 09:33 PM   #21
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Originally Posted by ESRBob View Post
My concern with Cliffp's approach iare three-fold: First, it could lead you to investing in risky high-yielding investments all the while telling yourself how safe you are because 'you're only spending dividends and not touching principal'.

Second: plenty of high yielding securities, such as MLPs are actually paying you back a portion of your capital each year in that dividend -- you'll sometimes learn exactly how much because you actually get different tax treatment on the two portions and the 1099 or k1 will tell you as much. Our reptilian pleasure-seeking brains may choose to ignore all those niceties and just say, "i'm safe, since I'm only spending dividends'. The principal may even be holding steady.... until you factor in inflation. And if it does better than overall interest rated after doing all that math, it's because you're taking on extra risk-- see point 1.

Third, investing this way tends to produce less-diversified portfolios full of blocks of individual securities. These can leave you more vulnerable to capital loss when shifts in the economy affect those stocks or sectors, even though the securities themselves are no more or less risky than the market overall.

Finally, when we/I go down the road of saying we'll 'just spend dividends' ,before long we've begun to substitute that with 'just spending dividends and interest'. And then you're at risk of spending principal in a new way -- your fixed income investments' interest payments are in fact an inflation-adjustment plus interest. So you really need to set aside 3% or this year's inflation rate first, and then spend whatever interest is left. Otherwise you're spending principal, even if it takes you 20 years to find out. Or buy TIPS and spend that interest -- that will get you 2% or so.

So you're back to the cruel math that safely 'living off dividends and interest' in a properly diversified and calculated portfolio puts you at market averages, which means you're probably at a 2.5% SWR, which just means you need to work a lot longer to get to the required portfolio size of 40x spending. You'd be real safe, but you'd also be working longer -- maybe even until age 65+. And missing out on all the fun here!
1. Clif posted his suggested portfolio and it includes no risky high-yielding investments.
2. He doesn't include any MLPs.
3. 70% of his money is in funds. As for the other 30% he has suggested differing industries. I can vouch that this is my approach and my industry diversification is very close to the Wilshire 5000 index distribution (using no funds at all).

As for "dividends & interest" you aren't giving weight to the fact that with his approach the dividends are generally appreciating faster than inflation. Per clif's example, he has $16k coming from dividend income. Assuming a historical average annual dividend increase of about 5-6% is probably reasonable. So, you are looking at $800-$1000 in increase the first year compared to a likely 3% inflation ($1,200). Those numbers can be tweaked to the desired result by increasing the equities allocation and/or a very slight increase in the overall principal (not from 25x to 40x). And that's before considering whether dividend stocks are less volatile and therefore improve the worst case monte carlo simulations.
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Old 07-14-2007, 10:00 PM   #22
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Pretty much true, but ESRBob's points are really, really well taken.

Dont chase the yield and forget about growth of principal.
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Old 07-15-2007, 05:23 AM   #23
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Surely by that time she will not be throwing it all away on black nail polish, strange hair coloring, Netflix, Wii, and the like, before funding her own accounts.
Hey, Netflix is pretty good deal for those who LBYM, it works out to be
about $1 per DVD rental, its cheaper than cable!
TJ
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Old 07-15-2007, 06:32 AM   #24
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This discussion is a matter of managing the spending pattern and the overall resources of the portfolio over time. We have a step-down spending pattern projected as we age. Plus, @ 4% our ER spending is projected @ 125% of our current spending. And that is based on Gross Income. I know our tax bracket will be lower when we ER. In other words a lot of discretionary spending.

The 4% limit rule is a great guideline. Whether it is 2%, 4%, or 10% (what changes is the probability of success/failure). [Note: I am assuming a sensible portfolio allocation... nothing extremely risky.] Plus your WR could be adjusted from year to year. IMHO it really depends on the dynamics of how we will make common sense adjustments along the way. Spend more early, tighten the belt later... whatever people decide (it can work). You just need to understand the implications of possible futures.


@ 100% success probability, you are very likely to forgo consumption and leave money in the estate. If that is your goal, then fine. On the other hand, one can use a 70% or 80% success model and make adjustments along the way. They are still more likely to forgo consumption and leave money behind.

It seems that people planning for a bare-bones retirement are the ones at the most risk (little discretionary spending for regulating the success rate).

Understanding your spending/income needs and establishing a floor. That basic income floor needs to be managed very conservatively (i.e., very little risk). This seem to be the key! For example: if one needed $40k/year (inflation adjusted) for the next 40 years to meet basic expenses (with small, yet acceptable amount of discretionary spending)... they should guard that carefully. The rest IMHO, can be spent much more freely.

You folks who have FIRED (or intend to) below 50 years of age are in a bit of a different situation. Most of my comments are stated from the FIRE @ 55 perspective.

I am not as fortunate as Money Bags (er Bunny Dude). He lives in CA (nice climate) and was able to FIRE in his 40s. Then again... maybe I am too conservative. His situation (as he described it) sounds similar to mine... But I have been sticking with work.
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Old 07-15-2007, 08:10 AM   #25
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As Chinaco is saying above, much of this comes down to one's age. If you plan to have $1 million and it throw off $40,000 per year to live on, in the beginning you do not want to touch the principal. At some point, you can take $20,000 per year from the principal, which would raise your withdrawal rate to 6% that year and leave you with $980,000. Even if the portfolio only returned 4% per year for 10 years, the extra $20,000 yearly withdrawal would not leave you that much south of $800,000. The magic question is when to start invading the principal for extra current consumption. The earlier you start, the better chance of running out of money. The later you start, the better chance of leaving a large, or even massive estate.

Someone once gave me a good rule of thumb that I never forgot. He is assuming very modest future long-term market returns of 7%, which is a few points below the historical return for a mostly stock/bond portfolio. Then he assumes 3.5% inflation rate which leaves a 3.5% withdrawal rate. Not scientific, but interesting nevertheless. Obviously if future returns are better or inflation lower, this would substantially grow the portfolio, allowing for greater withdrawals.
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Old 07-15-2007, 11:40 AM   #26
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Hey, Netflix is pretty good deal for those who LBYM, it works out to be
about $1 per DVD rental, its cheaper than cable!
TJ
You can do way better than that! I signed up for a month, discovered you could upgrade your account and if you downgraded before the end of the billing cycle, you werent charged for it. So I bumped to the "8 out plan" that they dont have anymore.

Laptop. 320GB external hard drive. DVDDecrypter. DVDShrink. WinDVD. RGB cable to the Infocus projector. Optical dolby digital out to the home theater. One day mail turnaround to the nearest netflix distribution center. About 150 movies for 2 months worth of "four out" netflix plan. And yes, they absolutely positively started "throttling" me after the first six weeks.

For those unfamiliar, if you turn your movies around too quickly, netflix stops sending new movies immediately and starts adding delay days to your selections.

I dont think we even finished watching them...2 years went by and the stuff was coming out on HBO and Starz.
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Old 07-15-2007, 02:27 PM   #27
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Please correct me if I'm wrong, but I'm pretty sure I read on one of the ER threads that the federal tax rate on dividends will jump in a few years from 15% to a max of close to 40% depending on income (plus state tax if applicable).

1. Is this true?

2. If it is, how will it affect your investment decisions?
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Old 07-15-2007, 05:17 PM   #28
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Please correct me if I'm wrong, but I'm pretty sure I read on one of the ER threads that the federal tax rate on dividends will jump in a few years from 15% to a max of close to 40% depending on income (plus state tax if applicable).

1. Is this true?

2. If it is, how will it affect your investment decisions?
1. TRUE, For 2011, the current tax relief act is suppose to run out,
so dividends are suppose to be treated as normal income.
2. I don't make enough off of dividends from taxable accounts to
worry about it.
TJ
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Old 07-15-2007, 06:29 PM   #29
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On the Diehard's site (diehards.org), I read a great thread recently where Rick Ferri said up to 5% is usually a safe WD rate for people who do not intend to leave an inheritance.
That is what I intend to do. 5% using the 95% rule.
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Old 07-15-2007, 06:46 PM   #30
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Finally, when we/I go down the road of saying we'll 'just spend dividends' ,before long we've begun to substitute that with 'just spending dividends and interest'. And then you're at risk of spending principal in a new way -- your fixed income investments' interest payments are in fact an inflation-adjustment plus interest. So you really need to set aside 3% or this year's inflation rate first, and then spend whatever interest is left. Otherwise you're spending principal, even if it takes you 20 years to find out. Or buy TIPS and spend that interest -- that will get you 2% or so.

So you're back to the cruel math that safely 'living off dividends and interest' in a properly diversified and calculated portfolio puts you at market averages, which means you're probably at a 2.5% SWR, which just means you need to work a lot longer to get to the required portfolio size of 40x spending. You'd be real safe, but you'd also be working longer -- maybe even until age 65+. And missing out on all the fun here!
I don't disagree with many of your points Bob but....

First we have to consider a dividend income withdrawal in the context of alternative withdrawal strategy. Lets take look at a modify Couch Potato Portfolio 60% Vanguard Total Stock Market 40% Total bond Fund. In good market years you sell enough of the Stock fund each year to transfer the 40K+ to your checking account for expenses and perhaps have some left over to purchase more of the bond fund to bring your allocation back up to 60/40 (or whatever your target AA is). So instead of spending income (like my approach) you are spending principal. Now this isn't psychologically so bad when the market is going up. But lets take a year when interest rates raise modestly and the economy looks like it will will be down.

In this scenario your Stock fund may end the year worth 450K (down 25%) and the interest earned in the bond fund may just break even. You have to sell a large amount of the bond fund ($76K) to pay for living expense and buy a bit more stocks. If the bear markets continues for a 2nd or God forbid a 3rd year an ER may start polishing up at resume, despite the theoretical assurances of FIREcalc, the Trinity study etc that in the end 4% is a SWR.


The fact the 3 year bear market happened to me after my very early retirement in 1999 (although falling interest rates helped my bonds) is the main reason I advocate for a dividend income approach. Pyschologically I found it a lot easier to stomach the bear market because both the REITs I owned and the traditional blue chip dividend payers like RJR and CAT were regularly increasing their dividends even while the stock prices were dropping. So while my net worth was dropping my "income" was increasing.

Maybe I am spoiled but the only stock I've ever owned that cut dividends was Ford. I guess I am more willing to take the risk of a few companies suspending or cutting dividends in contrast to risk of waiting out an extended bear market as a retiree.

Now you may very well be correct that a dividend income strategy provides somewhat of an illusion of lower risk. But I think it can make sleeping easier during bear markets for many early retirees.
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Old 07-15-2007, 07:45 PM   #31
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My concern with Cliffp's approach iare three-fold: First, it could lead you to investing in risky high-yielding investments all the while telling yourself how safe you are because 'you're only spending dividends and not touching principal'.

Second: plenty of high yielding securities, such as MLPs are actually paying you back a portion of your capital each year in that dividend -- you'll sometimes learn exactly how much because you actually get different tax treatment on the two portions and the 1099 or k1 will tell you as much. Our reptilian pleasure-seeking brains may choose to ignore all those niceties and just say, "i'm safe, since I'm only spending dividends'. The principal may even be holding steady.... until you factor in inflation. And if it does better than overall interest rated after doing all that math, it's because you're taking on extra risk-- see point 1.

An additional comment on MLP (I own several despite not recommending any in my post), you are correct that for taxes purposes a lot of the MLP distributions are treated as return of capital. Still I think it is useful to separate assets which really depreciate from those which have a far longer life with good maintenance.

A huge amount of the capital expenditure Intel builds a new chip plant is gone after a few years because the technology changes so rapidly. A shipping company may buy a new bulk shipper and depreciate over 30 years and by the end of 30 years it will worth considerable less due to high maintenance cost. In contrast most MLP own assets like pipelines which have useful lives in the 50 -100 year range. Now for tax purpose it appears like return of capital, but in reality the lifespan (and hence the economic value) of these assets exceed my own life expectancy. Last year many of these MLP were yielding 7-9%, and most have the prospect of raising distributions at least as fast as inflation. Pipelines are regulated and general rates increase at roughly inflation levels. At current yields of 6% the risk/reward ratio of most MLPs vs a 6% CD looks fairly marginal.

For this reason I look at energy MLPs as similar to TIPs or more accurately corporate inflation bonds like Sallie Mae's OSM/ISM, but with a 2-4% yield premium.

In fact, my dividend income approach asset allocation looks like this
10-35% cash and bonds (mostly government)
35-60% Stock index funds
The remainder is in "income" investments, these include high yield stock like tankers, MLPs, cover call premiums, REITs, and traditional blue chip stocks with high dividends like Bank of America. Now these "income" investments are fairly diversify group but they share some common attributes.
  1. An expected total return of 4-6% over T-Bills
  2. Much of the return comes in the form income not capital gains
  3. Less volatile than the overall market
  4. Fairly sensitive to interest rates.
There are of course risks associated with this strategy, including sector risk, and individual company risk. Probably the biggest risk is the "no home run" effect. I may ocassionally get a stock that double or triples, but I think there is no chance that an MLP, a BofA, covered call, or even a tanker stock will be the next Microsoft, Starbucks, or Google.

The upside is a more predictable income flow, with reasonable inflation protection.
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Old 07-19-2007, 12:35 AM   #32
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Cliff,
Intriguing point about the difference in underlying assets held by MLPs, and in the fact that the return of capital portion may be primarily for tax advantages, and not actually represent that you are getting your own capital back. I've long been interested in them as an asset class, though I do know people who have spent the entire 7-8% distribution each year and considered it to be a safe withdrawal.

My feeling can be summed up by the following thought experiment: Assume two FIREes have the same exact million dollar portfolio, in a 60-40 blend with some higher dividend funds/stocks tossed in. One spends the interest and dividends each year, while the other one spends 4% of the portfolio's value. It is quite plausible that they find after 10 years that they have each spent/withdrawn about the same amount for their portfolios each year. Given that, how important is it that one was choosing to spend that 40k or 50k each year based on spending dividends and interest, while the other was busy calculating 4% of portfolio value, then moving that from the accumulated dividends and interest that had been piling up in the MM account all year into a checking account for spending.

My guess is that this scenario is not too far from reality, most years.

So if you are in fact being a conservative, sensible investor you'll steer clear of the 'if I buy high-yield stuff I can safely spend more every year' Kool-Aid, and end up fine either way you are comfortable going -- essentially owning the same sort of portfolio and spending the same amount whether you think of yourself spending dividends and interest or spending 4.x% of the portfolio.

Anybody ever do any comparative what-ifs along those lines?
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Old 07-19-2007, 05:20 AM   #33
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I'm planning to live off the dividends and interest as well. I'm trying to balance such that a 2.5% yield on dividends plus a 4-4.5% muni rate of return will cover that as well as keep my taxes low and allow me to re-allocate depending on how I see the future unfolding. FireCalc tells me I'll be 100% successful based on my very very conservative anticipated needs (read more than I spend now, by a wide margin) at a 2.5% WR. That means probably leaving a pile behind, but it also means I could spend more and not worry about it. My AA will always include enough cash to get me thru a 3-4 year bear run, and will be invested in a variety of CDs, California MMs (in addition to the Cali muni bonds and treasuries in my bond funds), and should itself earn about 3-4% after tax, covering inflation during a bear run. Any muni interest or dividends will go into a california MM sweep fund and will be used to "cash up" the cash portion, as well as to re-allocate as the times dictate. As for my CDs, it is my intention to balance some shorter ones with some longer ones so there is always cash available, but that might not even be necessary if checking interest continues to perform well (4.25% at Schwab at the moment). I don't mind leaving a pile behind as long as I can spend what I want during retirement. On the other hand, I don't mind if I spend my last dollar on my last day in this realm either (or my wife's last day) but it must last that long. That's why I'm shooting for the 2.5% WR...very safe, very conservative, but I gotta w*rk 23 more months to get there...actually 17 months but will wait until my daughter finishes HS to pull the plug.
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Old 07-19-2007, 08:21 AM   #34
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Cliff,

Anybody ever do any comparative what-ifs along those lines?
No but I have some random weird thoughts - which should be taken with a grain of salt since I think they are period specific(90's), possibly due to my specific mix of dividend stocks(see Bernstein's 15 Stock Diversification Myth) and therefore hard to assess risk or ability to replicate.

Jan 93 I was unemployed(aka before the mental shift to ER) with 16 wks severance, a pile of dividend stocks in DRIP plans, and a rental duplex. My big dog 401k was rolled over to Vanguard and at 49 was looking at a 72t distribution. At full throttle cheap mode - income was looking at 50% rental, 50% dividends until age 55 when a small pension kicked in. Skipping the other stuff(very complicated) like temp job, a tornado hit, for sale by owner/divorce/big cap gain - stuff happens.

Over with the silly dividend stocks - best guess I took out 8% - a large (maybe 50% handgrenade wise) amount as cap gains/principle due to spin offs, mergers and sells after dividend cuts - and it seemed to occur in lumps, bumps, and waves (93-2003). Very messy spreadsheet wise. Value gets periodically discovered and bought/merged - my turnover was way higher than I planned.

Net, net I lived a lot (??40% at the peak?) on 'dividends/dividend stock' while my balanced index rollover compounded thru the 90's because I never took any 72t.

I cannot say one - div's vs index blew the barn doors off the other. My point is that div strategy can be so broad as to make it hard to assess risk or figure portfolio performance( Bernstein's TWD, terminal wealth distribution).

heh heh heh - of course that's why 'widows and orphans' portfolios were constructed back in ancient times.
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Old 07-19-2007, 08:38 AM   #35
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We totally ignore dividends when deciding between competing investments. We consider stock repurchase plans as equally attractive. The combination of dividend buildup and capital released in quarterly rebalancing feeds the necessary liquidity that we need to keep for SWR. We keep about 2 years of SWR in liquid holdings. Of course, tax planning is a bit more complicated than using a straight dividend approach owing to the varying ACBs.
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Old 07-19-2007, 04:59 PM   #36
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...
For those unfamiliar, if you turn your movies around too quickly, netflix stops sending new movies immediately and starts adding delay days to your selections....
(I don't know anything about the original topic). I looked into Netflix once when my library didn't have videos I needed for a drama class. Netflix also didn't have any of them so I bought them from Amazon and turned a nice profit selling them back, that's the fun of scarcity. The Netflix fee would be an annoying recurring expense in LBYM.
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Old 07-19-2007, 09:07 PM   #37
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For those unfamiliar, if you turn your movies around too quickly, netflix stops sending new movies immediately and starts adding delay days to your selections.
I turn them around next day and have been for years, they do the same,
so its a 3 day cycle, mail them on monday, tuesday turnaround, recv them
on wednesday. Maybe your distribution center is a union shop
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Old 07-19-2007, 10:05 PM   #38
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Seems like theres some variability to the behavior and I think it has something to do with new releases...more of those you go through the more throttling. Also depends on how long you hold them.

A couple of guys in different cities proved the 'conspiracy' out by creating multiple users at different physical addresses all within the same neighborhood (their house, a girlfriend, and parents or grandparents IIRC). Ordered the same movies but had one turn them around in 24 hours, 3 days and a week. After a few months the new releases in the 24 hour users queue were showing a week to two weeks before they'd be available. Same movies in the 3 day queue showed that they'd be a few days to a week. The 7 day users queue showed immediate availability.

The 'throttling' rule was actually added to the netflix TOS sometime in 2005 after they paid a class action suit on the matter.

IIRC once you get to the point where they're getting under $2 a movie, the throttle kicks in to keep you at or above that level.

Judge approves Netflix ‘throttling ’settlement - U.S. Business - MSNBC.com
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Old 07-20-2007, 03:41 AM   #39
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Seems like theres some variability to the behavior and I think it has something to do with new releases...more of those you go through the more throttling. Also depends on how long you hold them.

A couple of guys in different cities proved the 'conspiracy' out by creating multiple users at different physical addresses all within the same neighborhood (their house, a girlfriend, and parents or grandparents IIRC). Ordered the same movies but had one turn them around in 24 hours, 3 days and a week. After a few months the new releases in the 24 hour users queue were showing a week to two weeks before they'd be available. Same movies in the 3 day queue showed that they'd be a few days to a week. The 7 day users queue showed immediate availability.

The 'throttling' rule was actually added to the netflix TOS sometime in 2005 after they paid a class action suit on the matter.

IIRC once you get to the point where they're getting under $2 a movie, the throttle kicks in to keep you at or above that level.

Judge approves Netflix ‘throttling ’settlement - U.S. Business - MSNBC.com

Their expenses were getting out of line and that was a way to handle it. They oversold and/or underestimated customer demand and therefore underestimated profitability. This technique helped someone to make quarterly/yearly profit margins! Besides what you don't know won't hurt you, right! You aren't being scr3wed... its called expense management. Of course, you didn't see them take the route of canceling any of the less profitable customers' memberships! They have ways of making you profitable.

Think of it this way. There were a bunch of sh!theads marketing people sitting in a conference room for weeks trying to figure out a solution. Those selfish consumers were taking advantage of poor old netflix. They really didn't mean unlimited rentals! That was just an advertisement.


Come on, get with the program! All you can eat... as long as you don't eat too much!
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Old 07-20-2007, 07:29 AM   #40
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My plan is to live off dividends which will likely produce 2.5-3 percent of the portfolio balance. I dont intend on withdrawing any of the capital and let it grow over time.
Hello Fraser,

That is a good plan, and I second Audrey's comments.

You would probably be interested in reading the book Stop Working: Here's How You Can, by your fellow-Canadian Derek Foster [see generally Book Review: Stop Working: Here's How You Can]. Foster's strategy is very similar to the one that you describe. You can order the book from his website, but most libraries will have a copy.

Milton
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