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Dividends and/or Safe withdrawel rate
Old 07-13-2007, 10:39 AM   #1
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Dividends and/or Safe withdrawel rate

Hi, Fraser here
Short-time lurker, first-time poster

I have seen a lot of posts regarding safe withdrawal rates but don't see many/any posts on living off dividends. 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. When people talk about 3-4% withdrawal rate, are they including dividends, or is this in addition to dividends? If its in addition, then can I reasonably expect to live off say 6% of the portfolio each year?

I figure I'm 7-10 years from FI using just dividends, but if I can draw on the capital, it could happen in half the time. I look forward to any comments/criticisms of this plan.

Fraser
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Old 07-13-2007, 11:03 AM   #2
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No, not in addition! The safe withdrawal rates most definitely include dividends! During some past market periods, dividends were the major (if only!) contributor to the portfolio total return.

If you can manage to live off of mostly stock dividends then you are really set. Your portfolio principle will keep up with inflation, and your dividends will naturally increase over time as well.

People don't usually describe this approach because it requires such a large portfolio! Stocks don't yield very much these days, as you noted 2.5% or so is perhaps the most you can expect. But if you can live off that, you are sitting pretty!

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Old 07-13-2007, 11:04 AM   #3
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The 3-4% rate includes all withdrawals from the portfolio - dividends, interest, realized capital gains, spending of principal, etc. If your portfolio is large enough that you can live off a 2.5%-3% dividend yield without having to sell any stocks that would be excellent, since dividend growth tends to exceed inflation as measured by the CPI by a significant margin. If your portfolio is diversified, you will probably be able to ride out market fluctuations without ever having to sell stocks in a down market.
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Old 07-13-2007, 11:44 AM   #4
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Before marrying a part time working spouse, we lived off of dividends. Now its dividends plus her paycheck, and we have money left over to roll back in. At least we used to, prior to buying our new money pit...

When she finally quits working, we'll probably continue with that strategy, unless some tax change makes qualified dividends less pleasing to employ than long term capital gains.
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Old 07-13-2007, 12:48 PM   #5
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Welcome to the board, Fraser!

Quote:
Originally Posted by fraserrc View Post
When people talk about 3-4% withdrawal rate, are they including dividends, or is this in addition to dividends? If its in addition, then can I reasonably expect to live off say 6% of the portfolio each year?
They're talking about whatever the portfolio throws off-- interest, dividends, and realized cap gains. The basic idea, which can easily be made incredibly complicated, is to take 3-4% out of your portfolio at the beginning of the year and live off that. Or take whatever extra you'll need after dividends & fund gains are transferred to your checking account.

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Originally Posted by fraserrc View Post
I have seen a lot of posts regarding safe withdrawal rates but don't see many/any posts on living off dividends. 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.
Well, the math may delay your ER.

If you're living off a 4% dividend then you need an ER portfolio that's 25x your annual spending (1/0.04). If you're going to live off dividends, without invading the principal, then you're going to need an ER portfolio that's 33-40x your annual spending-- but it's a lot less likely to fail.

Only you can decide if the extra cushion is worth the price of the extra years of slave savings.
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Old 07-13-2007, 04:03 PM   #6
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Welcome to the board, Fraser!



Well, the math may delay your ER.

If you're living off a 4% dividend then you need an ER portfolio that's 25x your annual spending (1/0.04). If you're going to live off dividends, without invading the principal, then you're going to need an ER portfolio that's 33-40x your annual spending-- but it's a lot less likely to fail.

Only you can decide if the extra cushion is worth the price of the extra years of slave savings.

I think the 33x-40x rule for dividends is true, but only if you rely on broad market indexes and not higher yielding dividend orient ETFs or individual securities. If you are comfortable picking individual securities I think it is reasonably easy to create a portfolio with an overall income level of 4% thus eliminating the need to dip into capital.

For example assuming a 60/40 equities/bond split on a $1 million portfolio

400K bonds/money markets @6% = 24,000/year
(possible with Pen Fed other credit unions)
200K S&P 500 fund/etf @1.75% = $3,500/year
100K EAFE International @1.90 = $1,900
Total income = $29,400
This leaves a shortfall of $10,600 of income to be earned by the remaining 300K.
An ETF like DVY is currently yielding 3.1% gets most of the way.
A smattering of high yield stocks like EGLE, or DSX @8% or CSE @10% mixed with old reliable dividend increasing blue chips like BAC @4.5%
JNJ @2.6% PFE @4.5% makes a portfolio with current income >4%.

Your income via dividends should increase at rate close to inflation.
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Not if most is interest
Old 07-13-2007, 04:44 PM   #7
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Not if most is interest

Money depreciates over time and interest along with it. A higher dividend yield usually means a more slowly growing stock along with the possibility of cuts in down years.
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Old 07-13-2007, 09:29 PM   #8
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I'm in clifp's camp. That's what I do with different percentages. If you are willing to wade through some B.S., the best dividend investing forum I've come across is the Dividend & Income Forum over at Morningstar (read-only unless you want to pay $5).
Income & Dividend Investing Discussion Board
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Old 07-13-2007, 09:44 PM   #9
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a 60/40 equities/bond split on a $1 million portfolio
Chicken!!!

Good post Clif.
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Old 07-14-2007, 06:57 AM   #10
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Chicken!!!

Good post Clif.
The proper technical terminology is 'chickenheartedness.'

.

heh heh heh - Target Retirement 2015(85%) plus Norwegian widow dividend stocks (15%) - including one file cabinet of DRIP's. I cheat and plan on taking 5% of 12/31 balance for a while - cause I'm in my 14th year of ER and were perhaps overly cheap the first 13.
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Old 07-14-2007, 08:50 AM   #11
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Audrey is correct, dividends are included.

Withdrawals really consist of two parts-
1.Total withdrawal from portfolio
2.Cash flow within the portfolio

Most studies using U.S. data suggest 4% total withdrawals from 60/40 market weight portfolios. Bonds and dividends provide cash flow within that portfolio. Overweighting of bonds and dividend paying stocks improve cash flow though likely at the cost of late life growth needed to offset inflation.
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Old 07-14-2007, 09:52 AM   #12
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And yet, most value stocks (often the payers of high dividends) outperform growth stocks during most historic periods by at least a couple of percentage points.

So I suppose its a matter of picking your funds/stocks. Choosing equities that throw off all their value as dividends is obviously a poor choice.

UM- I almost just went with "Bwawk! Bwawk! Bwawk!" but I had a 2 year old sitting on me and "chicken!" was easier to type with one hand.
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Old 07-14-2007, 11:46 AM   #13
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Thanks for all the comments,

I agree that having 30-40x needed annual cash flow should be my portfolio balance goal.
Here in Canada, Dividends (by Canadian companies) are taxed very favourably compared to capital gains and interest so if I can structure my portfolio primarily to produce cashflow by way of dividends it makes some sense.

Thanks again.
Fraser
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Old 07-14-2007, 03:07 PM   #14
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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.

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!
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Old 07-14-2007, 03:21 PM   #15
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I understand the 4% withdrawal rate .What I don't understand is how you spend down the principal if you do not want to leave a huge inheritance .Do you wait until you are 80 and say okay now the sky is the limit ?
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Old 07-14-2007, 03:56 PM   #16
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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.
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Old 07-14-2007, 05:14 PM   #17
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I understand the 4% withdrawal rate .What I don't understand is how you spend down the principal if you do not want to leave a huge inheritance .Do you wait until you are 80 and say okay now the sky is the limit ?
The thing is, the 4% withdrawal scheme doesnt produce an absolutely even terminal portfolio rate. In many of the various periodic 'runs' you get to 80 and have almost nothing left, but would rebound enough from 80-85 to maintain solvency.

Other times your portfolio grows to 4x its original size and you leave a pile.

You can spend it all when you're 80, but hope you dont live to 100.

This is that 'searching for a free lunch' odyssey...either you give all the money to an insurance company and pay a fee and lose your principal and control over it, or you establish a big buffer between you and bankruptcy and dont draw too much of it so as to destabilize it and have it run to zero on you.

Like annuities and social security, you cant do the math without knowing when you're going to die.
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Old 07-14-2007, 05:24 PM   #18
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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.
10% would avoid that inheritance even more quickly!

Rick gives good advice but for a known financial advisor to be making bold statements like that is really going out on a liability limb, even on the VD board. I bet he clenched every sphincter on his firm's legal staff.

But I enjoy watching he & Swedroe smack each other in public.
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Old 07-14-2007, 06:18 PM   #19
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Like annuities and social security, you cant do the math without knowing when you're going to die.
Since that is an unknown, instead I like to use the age at which I would like to be thrown penniless upon the system to be abused by sadistic "caregivers" at whatever crowded charity nursing home I might be tossed into when I am old, helpless, alone, and penniless.

The oldest living woman is about 115-116. That supplies a maximum age for me to use. Generally I play a little riskier game, though, and use 102. Longevity runs in the family.

If I die at 82, I won't care if I could have spent more because I'll be dead. In that event my daughter will probably appreciate any excess money. Hopefully by that time she will have matured enough to manage money wisely. (I can hope, anyway). 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.
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Old 07-14-2007, 08:01 PM   #20
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Since that is an unknown, instead I like to use the age at which I would like to be thrown penniless upon the system to be abused by sadistic "caregivers" at whatever crowded charity nursing home I might be tossed into when I am old, helpless, alone, and penniless.
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