Income investing and total return investing.

[clifp]

The often sensible Christine Benz from M* has two fine articles about the on-going debate of income vs total return investing for retirement.

Income vs.Total Return: Who Says You Need to Take Sides?

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Lately, I've seen signs of the same absolutism in the realm of another great investing debate: [As poltical debates] whether to manage a portfolio for income or total return. Even a hint of an endorsement for the total-return approach, as in this article, seems to set off the income absolutists.This is frustrating because when you take the time to examine the two approaches, it's clear that they're not polar opposites at all. By getting bogged down in semantics, I fear that some investors might miss the big picture.

As a conformed incomist I have to say she has many good points in the article.

The second article probably summarizes one of my biggest reasons for liking the income approach.

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But there's an area in which incomeniks have it all over the totalniks, and that's in ease of implementation in retirement. By using an income-oriented approach, you can create the equivalent of a steady paycheck in retirement (or attempt to, anyway). But tapping your principal periodically, as you're required to do with a total-return approach, isn't just psychologically difficult. It's also a logistical headache. You have to figure out which accounts to tap for cash, which in turn affects where you're holding liquid assets, and you also have to figure out how to tap your accounts in the most tax-efficient manner possible. Given that, it's no wonder that so many retirees are attracted to investments that kick off current income.

[Ken11]

Good article.
I agree with it.
Thanks for posting.

[GregLee]

Why in the second article does she say totalniks "have to" instead of saying they "get to"?:

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You have to figure out which accounts to tap for cash, which in turn affects where you're holding liquid assets, and you also have to figure out how to tap your accounts in the most tax-efficient manner possible.

These sound like advantages, to me.

[Chuckanut]

Maybe I am being nieve, but don't dividend come from the capital earned by the company. In other words, the 'growth' of the company is converted into a dividend that is paid to the share holders. If the dividend was not paid, the price of the stock would increase to reflect wealth not paid out. Ultimately, a dividend paying stock must generate some additional wealth (growth) to pay the dividend.

[clifp]

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Originally Posted by GregLee Why in the second article does she say totalniks "have to" instead of saying they "get to"?: These sound like advantages, to me.

They certainly aren't advantages from the point of simplicity. In fact I don't see them as advantages period. Dividend income already is taxed lighter than any form of income other than Roth withdrawals.

[GregLee]

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Originally Posted by Chuckanut Maybe I am being nieve, but don't dividend come from the capital earned by the company.

This view was recently discussed here: http://www.early-retirement.org/foru...ml#post1103484

[Texas Proud]

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Originally Posted by clifp The often sensible Christine Benz from M* has two fine articles about the on-going debate of income vs total return investing for retirement. Income vs.Total Return: Who Says You Need to Take Sides? As a conformed incomist I have to say she has many good points in the article. The second article probably summarizes one of my biggest reasons for liking the income approach. Quote: But there's an area in which incomeniks have it all over the totalniks, and that's in ease of implementation in retirement. By using an income-oriented approach, you can create the equivalent of a steady paycheck in retirement (or attempt to, anyway). But tapping your principal periodically, as you're required to do with a total-return approach, isn't just psychologically difficult. It's also a logistical headache. You have to figure out which accounts to tap for cash, which in turn affects where you're holding liquid assets, and you also have to figure out how to tap your accounts in the most tax-efficient manner possible. Given that, it's no wonder that so many retirees are attracted to investments that kick off current income.

I guess you missed this in the article...

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Embedding income producers into a total-return strategy has a couple of other key side benefits. One is tax management: Focusing on total return gives investors more control over when they harvest income from their portfolios and where it comes from--a particularly important consideration for investors with substantial assets in their taxable portfolios. A total-return-oriented investor might wisely decide to hold income-producing securities in her tax-sheltered accounts, while steering nondividend payers to the taxable account.

[easysurfer]

Nice article.

For me, need to take sides as I use a little of both. The income from dividends, I put into my emergency fund. Any amount which the income doesn't cover, I sell to replenish the rest.

On the otherhand, to mix Indexing and non-indexing, I like to totally index when I can and have a bit of an identity crisis, questioning my own motives when I don't index .

[Midpack]

Wish I could have read it. Having just entered the distribution phase, my focus has always been capital appreciation and not income. So i am coming from total return from the other side. I am starting to find my way to the middle...

[jebmke]

The logistical problem seems over-rated.

[clifp]

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Originally Posted by jebmke The logistical problem seems over-rated.

They aren't huge but they aren't trivial. Imagine if you have 8 funds, in 2 IRAs and one taxable account (which I believe is roughly average for the forum) with dividends and cap gains reinvested. You withdraw 4% a year of the remaining portfolio (with a minimum of 95% of the previous year). Now you don't want to sell all at once because your income variation will be very high if you pick a down day to sell. So you decide to sell monthly. That is 96 separate transactions a year even if they are commission free that is still a hassle in my book. Especially compared to simply having dividends and interest accumulate in a money market and than withdrawing an amount less than or equal to them.

[jebmke]

I have more than 8 funds and I only make one transaction per month. At the end of the month, I look at whether stocks are outside the rebalance band. If not, I sell bonds if so, I sell stocks. All interest and divs in taxable sweep to MM.

If stocks are really down to a point where you "don't want to sell" it means you should be selling bonds anyway.

[DblDoc]

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Originally Posted by jebmke I have more than 8 funds and I only make one transaction per month. At the end of the month, I look at whether stocks are outside the rebalance band. If not, I sell bonds if so, I sell stocks. All interest and divs in taxable sweep to MM. If stocks are really down to a point where you "don't want to sell" it means you should be selling bonds anyway.

I have about triple that and it takes me about 5 minutes monthly to update my spreadsheet. Of course I'm still putting the money in but it is the same, only in reverse. Post-FIRE I'll be able to consolidate some and make it even faster. I think the challenge in withdrawal is doing either strategy in as tax-efficient manner as possible and anticipating the RMD's.

DD

[clifp]

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Originally Posted by jebmke I have more than 8 funds and I only make one transaction per month. At the end of the month, I look at whether stocks are outside the rebalance band. If not, I sell bonds if so, I sell stocks. All interest and divs in taxable sweep to MM. If stocks are really down to a point where you "don't want to sell" it means you should be selling bonds anyway.

Well in that case you are acting like an income investor more than a total return, since you said earlier that you are living on less than your dividends plus interest. As an income investor I also rebalance when my AA gets out of whack.

Now imagine that you reinvest all interest and dividends in your funds like TR investor is "suppose to do". How would you go about funding your living expenses?

[DblDoc]

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Originally Posted by clifp Now imagine that you reinvest all interest and dividends in your funds like TR investor is "suppose to do". How would you go about funding your living expenses?

Why would you do that? Just sweep all dividends and interest into a MM account for expenses and then only sell what you need to make up the difference. If you have too much then reinvest it. But I guess at that point you are essentially a dividend investor...

DD

[Running_Man]

I think a small but unrecognized event is the dividend investor retains his share of the corporation he is invested in while the total return investor is slowly reducing his ownership of the companies in retirement.

The biggest potential risk of the total return investor which does not apply to the income investor is the stock market valuing stocks at different PE's due to the discount of future earnings at the current interest rate environment, which changes over time, the compression of PE's along with the reduction of ownership can be a very negative 1-2 punch which does not occur with the income investor. This is an independent calculation of versus a bear market or earnings reduction environment and I will grant that most people investing today have not had to invest in that environment, but at these low interest rates those risk are coiled like a wound watch.

[clifp]

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Originally Posted by DblDoc Why would you do that? Just sweep all dividends and interest into a MM account for expenses and then only sell what you need to make up the difference. If you have too much then reinvest it. But I guess at that point you are essentially a dividend investor... DD

Well in theory somebody who is pure bucket person should be reinvesting all of his cap gains/and dividends in bucket 3, and only be withdrawing from bucket 1. This is because as Mathjack alleges that dividends and interest are too risky of an investment to depend on for day to day living expenses.

However, I am with you why bother? Which gets back to a point I made in another thread. For the most part total return investors tend to be either people in the accumulation phase or people who's primary income is from a pension, rental and not their portfolio.

In practice, I think most of us are more of hybrid. In my case, while I have plenty of dividend payers in my IRA, I am more of total return person, because I'm not making withdraws from my IRA currently.

[WilliamG]

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Originally Posted by DblDoc Why would you do that? Just sweep all dividends and interest into a MM account for expenses and then only sell what you need to make up the difference. If you have too much then reinvest it. But I guess at that point you are essentially a dividend investor... DD

This is what we do. Dividends are not enough to meet our annual withdrawal requirement, so we sell what we have to to make up the difference. What are we? Hybrid I guess.

[GregLee]

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Originally Posted by Running_Man I think a small but unrecognized event is the dividend investor retains his share of the corporation he is invested in while the total return investor is slowly reducing his ownership of the companies in retirement.

That's not the way (as I understand it) that a total return investor looks at it, unless perhaps you mean how many shares you can vote when you go to the annual stockholders' meeting. It's not the number of shares you have that matters to your investment, it's the value of the shares. Aside from tax differences, you don't care whether a stock has no dividend but increases in price by 4% or it has a 4% dividend but does not increase in selling price. If you need to withdraw 3% from your holdings, in the first case you'll sell shares to make up your 3% and in the second case you can either do the same or take part of the dividend but reinvest the 1% you don't need. It's all just money, and what strategy you follow is dictated by tax considerations and your convenience. If you want to keep the same inflation-adjusted amount in your investment fund -- your "principle" -- then that will dictate how much you can withdraw in a year, regardless of whether your withdrawal is by taking a dividend, selling shares, or some combination. You can perfectly well have all growth stocks without dividends in your portfolio, withdraw an appropriate amount each year by selling shares, and (assuming the prices increase) keep the nominal value of your portfolio increasing to match inflation.