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Dividends vs Stock Sales & AA Help
Old 02-01-2014, 12:26 PM   #1
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Dividends vs Stock Sales & AA Help

I'm sure a piece of this has been covered in some thread but this might be a different sort of question I need help with.

1) I'm a dyed in the wool "never touch the principal" guy
2) My 40/60 portfolio is currently paying all the bills nicely (for now)
3) Common sense/'good-but-not great' performance/advisors/calculators all tell me that I should return to a 60/40 portfolio (I'm 62 yo)
4) A 60/40 would not pay the bills and would require that I back-fill with sales of equity shares, however it has the chance to improve the growth of the overall value of the portfolio.

My problem is that the idea of selling stock shares (even if they gain a higher return) is freaking me out!

I'm trying to wrap my head around the idea of selling shares which I view as a finite, non-renewable resource vs taking dividends/interest which I view as 'unlimited supply'. If I sell shares, they're gone forever but dividends pay me and my net worth isn't being slowly depleted.

Yes, I realize the pie has the opportunity to grow bigger in a 60/40 but the number of shares doesn't grow, only their value. Again, once the shares are gone, they're gone.

So, can someone steer me out of my weird mindset? How can I look at this differently? What am I missing?
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Old 02-01-2014, 12:39 PM   #2
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I would not go back to a 60/40 portfolio at 62 years old, but I'm a bit more conservative investor than others here. Maybe you could split the difference and go 50/50.

As for dividends vs shares, to me it makes no difference. I reinvest all my dividends anyway. But even if I didn't, when I look at my net worth, and I withdraw $5,000 to pay bills, I'm worth $5,000 less regardless of whether the $5,000 came from the sale of shares or the withdrawal of dividends.

Just by the fact that you are not reinvesting dividends means you are not allowing your portfolio to grow as quickly as it otherwise would. But that's OK, as you need to spend money to live. Don't get caught up in the psychology of thinking a dollar from one pot is different from a dollar from the other pot.
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Old 02-01-2014, 01:17 PM   #3
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Originally Posted by marko View Post
I'm sure a piece of this has been covered in some thread but this might be a different sort of question I need help with.

1) I'm a dyed in the wool "never touch the principal" guy
2) My 40/60 portfolio is currently paying all the bills nicely (for now)
3) Common sense/'good-but-not great' performance/advisors/calculators all tell me that I should return to a 60/40 portfolio (I'm 62 yo)
4) A 60/40 would not pay the bills and would require that I back-fill with sales of equity shares, however it has the chance to improve the growth of the overall value of the portfolio.

My problem is that the idea of selling stock shares (even if they gain a higher return) is freaking me out!

I'm trying to wrap my head around the idea of selling shares which I view as a finite, non-renewable resource vs taking dividends/interest which I view as 'unlimited supply'. If I sell shares, they're gone forever but dividends pay me and my net worth isn't being slowly depleted.

Yes, I realize the pie has the opportunity to grow bigger in a 60/40 but the number of shares doesn't grow, only their value. Again, once the shares are gone, they're gone.

So, can someone steer me out of my weird mindset? How can I look at this differently? What am I missing?
You are not missing anything. You are just looking at it the same way it has been looked at for 100s of years, rather than the post war total return approach that has become popular.

I'll do either, but I do not like to spend capital gains, so actually I more or less follow the old approach.

Pay your money and take your choice. I can see arguments for either approach, and pitfalls in either. If the amount of dividends and interest available will not cover expenses, some people just ratchet up the risk, which is not a good idea.

Ha
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Old 02-01-2014, 01:38 PM   #4
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I'm a 60/40 guy here who lives off divys and bond interest. Usually try to avoid selling the divy producers, however, a few of my holdings that have cut divys (CTL, FE) have taught me that things can change.

Now I am not afraid to sell something IF I think it's price has gotten ahead of itself. Nothing wrong with taking a profit and waiting for the opportune time to reinvest those proceeds in the same or different equity.
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Old 02-01-2014, 04:56 PM   #5
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Originally Posted by marko View Post
I'm sure a piece of this has been covered in some thread but this might be a different sort of question I need help with.

1) I'm a dyed in the wool "never touch the principal" guy
2) My 40/60 portfolio is currently paying all the bills nicely (for now)
3) Common sense/'good-but-not great' performance/advisors/calculators all tell me that I should return to a 60/40 portfolio (I'm 62 yo)
4) A 60/40 would not pay the bills and would require that I back-fill with sales of equity shares, however it has the chance to improve the growth of the overall value of the portfolio.

My problem is that the idea of selling stock shares (even if they gain a higher return) is freaking me out!

I'm trying to wrap my head around the idea of selling shares which I view as a finite, non-renewable resource vs taking dividends/interest which I view as 'unlimited supply'. If I sell shares, they're gone forever but dividends pay me and my net worth isn't being slowly depleted.

Yes, I realize the pie has the opportunity to grow bigger in a 60/40 but the number of shares doesn't grow, only their value. Again, once the shares are gone, they're gone.

So, can someone steer me out of my weird mindset? How can I look at this differently? What am I missing?
My mind set is similar. On the other hand at some age it is ok to "dip into the principal. Good chance you'll live another 30 years probably no chance you live another 50, so spending 1 or 2% is probably ok especially because on average the dividends from the remaining 59% or 58% are going to be growing fast than inflation.

Alternatively and what I have done is construct a portfolio which is heavily dividend focused. From total return prospective it probably doesn't make a huge difference, but psychologically it does at least for me. I view as sacrificing future growth potential in order to have cold hard cash to pay the bills today.

With the low bond interest rates, it should not be too hard to do a bit of slicing and dicing to beat the Total Bond Market yield of 2.54%. For instance Vanguard REIT has 4.11% yield and Vanguard High Dividend yield VYM has yield of 3.0%. Switching the 20% to funds like these two
should provide you with equivalent income to what you are seeing today.
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Old 02-01-2014, 05:35 PM   #6
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I don't think it's a "weird mindset" at all. We all have to land on what works for us as individuals. I take a similiar approach and both a conservative equity allocation (30/70) and looking at them as income producers has enabled me to stay the course when they've been hammered. In fact, makes it easier to buy more at that point as well since they're yields are usually higher. You may find this attached study about allocation from perspective of minimizing downside risk useful.

https://content.putnam.com/literature/pdf/PI001.pdf

I'm much more concerned about stocks tanking than I am about interest rates rising. There are very few times in history stocks have been this expensive and we've recently experienced how quickly and deep their decline can be. Again, whatever works for you but downside protection is much more valuable to me than upside potential.
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Old 02-01-2014, 07:03 PM   #7
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I don't think it's a "weird mindset" at all. We all have to land on what works for us as individuals. I take a similiar approach and both a conservative equity allocation (30/70) and looking at them as income producers has enabled me to stay the course when they've been hammered. In fact, makes it easier to buy more at that point as well since they're yields are usually higher. You may find this attached study about allocation from perspective of minimizing downside risk useful.

https://content.putnam.com/literature/pdf/PI001.pdf

I'm much more concerned about stocks tanking than I am about interest rates rising. There are very few times in history stocks have been this expensive and we've recently experienced how quickly and deep their decline can be. Again, whatever works for you but downside protection is much more valuable to me than upside potential.

The problem with studies like this is optimum AA is almost entirely dependent on on the assumed rate of returns.

In the case of the study he assumes stocks have a real return of 6%, 3% for bonds and 1% for cash and volatility of 16%, 7%, and 2.5%.


Now the big unknown is stocks. 6% is historically a bit on the low side, but certainly a reasonable guess. On the other the Total Bond Market Yield is 2.54% - 1.5% inflation = 1.04% real return and cash 0.07%-1.5%= giving a negative 1.43% return.

In the world we actually live in you can't get 3% real returns in bonds or 1% real returns on cash, and absent a prolong period of deflation you aren't going to get those type of returns any time soon. So sticking 80-90% of your asset into fixed income of and than withdrawing 6%-8% (even for a 65 year old) as the author suggests is just bat **** crazy.
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Old 02-01-2014, 07:51 PM   #8
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I don't see what the big deal is. In good stock years, you sell some stock shares to help pay expenses and keep your AA at 60/40. In bad stock years, you buy back those stock shares to help keep your AA at 60/40.

Thus the shares you sell are NOT gone forever. You just buy them back at cheaper prices in the future.
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Old 02-01-2014, 08:09 PM   #9
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If equities follow history and rise faster than bonds, your 60/40 portfolio will become 60+/40-. Selling some equities not only gives you money to pay the bills, but is also necessary to keep your portfolio in balance. You may own fewer shares of the equities, but they are worth more. If you think about it, if the stock splits 2:1, do you feel like it would be ok to sell half your shares because you'd still have the same number of shares as before? I would hope not. I think this shows that it is not the number of shares that is important, but the value of the shares.

The bottom line is that you have to be comfortable with your plan, because nobody else pays the consequences of a strategy going bad for you. If you want to stick with not touching the principal, by all means, stick with it. I only posted the above because you asked for help steering you out of that mindset, or as I took it, presenting an alternative. It also happens to be the one I am comfortable in going with for myself.
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Old 02-01-2014, 08:15 PM   #10
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I don't see what the big deal is. In good stock years, you sell some stock shares to help pay expenses and keep your AA at 60/40. In bad stock years, you buy back those stock shares to help keep your AA at 60/40.

Thus the shares you sell are NOT gone forever. You just buy them back at cheaper prices in the future.
And the farther down the market goes, the more shares you get -- you just get richer and richer the more the market tanks!
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Old 02-01-2014, 08:18 PM   #11
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I don't see what the big deal is. In good stock years, you sell some stock shares to help pay expenses and keep your AA at 60/40. In bad stock years, you buy back those stock shares to help keep your AA at 60/40.

Thus the shares you sell are NOT gone forever. You just buy them back at cheaper prices in the future.

Rebalancing by moving money from stocks to bonds to stocks is one thing, but what am I supposed to buy back those stock shares with if I've spent the money on expenses?

Maybe here is where I'm stuck: I have $X portfolio with X shares. As time goes on the value goes up but the number of shares doesn't.

It's like having 1000 acres of land. If I rent the land to farmers, they pay me dividends and after 20 years, I still own the 1000 acres. OTOH, if I sell a few acres each year, eventually I'll end up with just one acre of land.

And yes, I'm not entirely against selling shares if the stock is a dog or if the WR is in the 1-2% range. Its the idea of selling 3-4% each year to make ends meet that spooks me.
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Old 02-01-2014, 08:58 PM   #12
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Rebalancing by moving money from stocks to bonds to stocks is one thing, but what am I supposed to buy back those stock shares with if I've spent the money on expenses?
You use your bond fund shares. And you bought extra bond fund shares when stock funds were doing great. In other words, you are not spending all your money on expenses.

Or you cut your expenses.

But you could go to 40/60 and not spend all your dividends by cutting expenses, too. That way, you could be using some of your dividends to buy more "principal".
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Old 02-01-2014, 09:02 PM   #13
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Here's a paper to read on all this: https://personal.vanguard.com/pdf/s557.pdf
It may not sway you, but it merits reading anyways.
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Old 02-01-2014, 10:01 PM   #14
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Maybe here is where I'm stuck: I have $X portfolio with X shares. As time goes on the value goes up but the number of shares doesn't.

It's like having 1000 acres of land. If I rent the land to farmers, they pay me dividends and after 20 years, I still own the 1000 acres. OTOH, if I sell a few acres each year, eventually I'll end up with just one acre of land.

And yes, I'm not entirely against selling shares if the stock is a dog or if the WR is in the 1-2% range. Its the idea of selling 3-4% each year to make ends meet that spooks me.
It is also worth noting that in almost all year companies are net purchasers of stocks. For instance in the last 10 years Intel has 19.7% less share outstanding, Microsoft 22.7%, JNJ 4.4%, Cisco 22%, and Bristol Meyers 14.8%. This year roughly 1/2 trillion dollars worth of share were purchased by the S&P 500 companies. So even selling a percent of two keeps your total ownership of the pie even.
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Old 02-02-2014, 08:18 AM   #15
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And yes, I'm not entirely against selling shares if the stock is a dog or if the WR is in the 1-2% range. Its the idea of selling 3-4% each year to make ends meet that spooks me.
Let me preface my remarks by saying I don't think you should switch your asset allocation to 60-40 from the current 40-60. Based on what you've said in this thread, you're doing fine with your current allocation. Increasing your stock allocation by 20% at your age seems unnecessary and motivated mostly by regret that you've missed out on much of the past five years' bull market. If stocks had performed poorly over the past five years, would you still think that "Common sense...tell[s] me that I should return to a 60/40 portfolio"? I doubt it. It's more likely that common sense would be telling you that your conservative portfolio is the best way to weather the uncertainties of the stock market and provide a secure retirement.

That said, I have serious doubts that the numbers you're presenting are anywhere close to your real life situtation. Where are you finding fixed income investments with such high yields that you can live off of dividends and interest at 40-60, but would need to sell "3-4% each year to make ends meet" at 60-40?

Let's say you have a $1 million dollar portfolio with $600,000 invested in PenFed CDs yielding 3%. I know of no higher yield in fixed income at the present that doesn't involve taking big risks in either credit quality or long maturities, or both. For stocks you have $400,000 invested in an S&P index fund with a dividend yield of not quite 2%.

With this mixture, you would currently be getting .03 * $600,000 = $18,000 per year in interest from your CDs and about .02 * $400,000 = $8,000 from your stock dividends. That's a total of $26,000, which you say is currently paying "all the bills nicely".

Now look at what happens if you reduce your PenFed CDs to $400,000 and increase your S&P 500 index fund to $600,000. Your interest is reduced to .03 * $400,000 = $12,000. This is partially offset by an increase in stock dividends to .02 * $600,000 = $12,000. The new total of interest plus dividends is $24,000 - only $2,000 less than the total from your 40-60 portfolio. That's the deficit you would need to make up from principal withdrawals. Your WR is only 0.2% of your $1 million portfolio - only about a tenth of the withdrawal rate you say you would be comfortable with. It's definitely no where near the 3-4% each year that you seem to be expecting.
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Old 02-02-2014, 08:32 AM   #16
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Let me preface my remarks by saying I don't think you should switch your asset allocation to 60-40 from the current 40-60. Based on what you've said in this thread, you're doing fine with your current allocation. Increasing your stock allocation by 20% at your age seems unnecessary and motivated mostly by regret that you've missed out on much of the past five years' bull market. If stocks had performed poorly over the past five years, would you still think that "Common sense...tell[s] me that I should return to a 60/40 portfolio"? I doubt it. It's more likely that common sense would be telling you that your conservative portfolio is the best way to weather the uncertainties of the stock market and provide a secure retirement.

That said, I have serious doubts that the numbers you're presenting are anywhere close to your real life situtation. Where are you finding fixed income investments with such high yields that you can live off of dividends and interest at 40-60, but would need to sell "3-4% each year to make ends meet" at 60-40?

Let's say you have a $1 million dollar portfolio with $600,000 invested in PenFed CDs yielding 3%. I know of no higher yield in fixed income at the present that doesn't involve taking big risks in either credit quality or long maturities, or both. For stocks you have $400,000 invested in an S&P index fund with a dividend yield of not quite 2%.

With this mixture, you would currently be getting .03 * $600,000 = $18,000 per year in interest from your CDs and about .02 * $400,000 = $8,000 from your stock dividends. That's a total of $26,000, which you say is currently paying "all the bills nicely".

Now look at what happens if you reduce your PenFed CDs to $400,000 and increase your S&P 500 index fund to $600,000. Your interest is reduced to .03 * $400,000 = $12,000. This is partially offset by an increase in stock dividends to .02 * $600,000 = $12,000. The new total of interest plus dividends is $24,000 - only $2,000 less than the total from your 40-60 portfolio. That's the deficit you would need to make up from principal withdrawals. Your WR is only 0.2% of your $1 million portfolio - only about a tenth of the withdrawal rate you say you would be comfortable with. It's definitely no where near the 3-4% each year that you seem to be expecting.
Thanks. I agree with your comment of "performance remorse", however 15% this year wasn't shabby...I do feel like I missed the boat to a certain extent.

I'm moderately heavy into high yield funds and other areas paying about 6.5-7% right now. I'm not risk averse, I'm depletion averse!

My "3-4%" comment was more of a reference/generic comment not meant to be taken literally; didn't mean to mislead.

In actual fact, a move more toward a 60/40 would mean a equity sale of about 2% annually; my portfolio is somewhat larger than the $1MM in your example. It's not the percentage of sale that bothers me as much as the concept of selling any shares! (other than negligible amounts).

Having said all that, I do appreciate the input and I found LOL's link to the Vanguard paper most helpful.
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Old 02-02-2014, 08:55 AM   #17
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Thanks. I agree with your comment of "performance remorse", however 15% this year wasn't shabby...I do feel like I missed the boat to a certain extent.

I'm moderately heavy into high yield funds and other areas paying about 6.5-7% right now. I'm not risk averse, I'm depletion averse!

My "3-4%" comment was more of a reference/generic comment not meant to be taken literally; didn't mean to mislead.

In actual fact, a move more toward a 60/40 would mean a equity sale of about 2% annually; my portfolio is somewhat larger than the $1MM in your example. It's not the percentage of sale that bothers me as much as the concept of selling any shares! (other than negligible amounts).

Having said all that, I do appreciate the input and I found LOL's link to the Vanguard paper most helpful.
Your numbers still don't add up. Even if you are averaging a full 7% on your fixed income investments, switching 20% to stocks yielding 2% would require a WR of only 1%. For the $1 million portfolio, your dividends plus interest would decline from $50,000 to $40,000 and you would have a $10,000 deficit to make up from principal withdrawals - exactly 1% of the portfolio. You could reduce this amount even further by investing in higher yielding stocks.

I would also like to point out that anyone who is currently averaging anywhere close to 7% in fixed income is in all likelihood taking on insane levels of risk that won't become apparent as long as the dividends keep on rolling in. To me that would be a great motivation to review my asset allocation - get out of high yielding fixed income before it's too late.
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Old 02-02-2014, 09:37 AM   #18
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I'm not risk averse, I'm depletion averse!
Any withdrawal is depletion. Money isn't smart enough to know which one of its siblings (dividends, principal) took the hit.
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Old 02-02-2014, 11:25 AM   #19
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Old 02-02-2014, 12:20 PM   #20
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Ok, ok, ok. I got the answers I needed; by and large extremely helpful.

I'll thank everyone now before thread drift takes hold.
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