Preserve Principal or draw it down?

[ERD50]

Quote:

Originally Posted by samclem We won't make any distinction between principal, the return from appreciation of assets, and dividends/interest. It's all in one pot and we'll take a certain percent of the year-end total. I'm not sure why I'd treat assets differently depending on where they came from. No one can accurately predict how share prices will grow over the coming decades, they might climb (and boost our portfolio) to very high levels: seems a pity to not spend that money just because I decided only to live on dividends. ...

Agreed, I'm scratching my head over some of these distinctions. Taxes are a factor, but other than that it's all about total returns. Anything else seems like an 'illusion' to me. A $ is a $.

One can invest in dividend paying stocks, and plan to only spend the dividends. Fine, but what leads them to believe those are going to keep up with inflation? If not, you are dipping into principal.

Of course I'm not saying it can't work, I just don't see where there is any inherent advantage over a total return approach with a wide mix of stocks/bonds in your AA of choice. Now, if you feel confident you have skills in picking individual stocks, maybe that means you can pick a great stable of dividend payers. But why not a stable of total return stocks? I don't get it.

Maybe people are saying they will adjust spending down if divs decrease? There are other ways to skin that - stick with whatever divs you get from a wide portfolio, and take any additional out as a % of the portfolio, rather than inflation adjusted WD.

-ERD50

[audreyh1]

Total return person here too, although I do like to see my portfolio keep up with inflation even after withdrawals.

I don't mind drawing the portfolio down some in my older years.

[Animorph]

Didn't we just do this? But I can't find the thread.

I expect my portfolio will grow in real value, as indicated by the majority of outcomes in FIRECalc. However, if we get stuck in one of the less happy outcomes I will spend down as necessary, in addition to cutting expenses a bit.

+1 on total return investing.

[bbbamI]

Quote:

Originally Posted by audreyh1 Total return person here too, although I do like to see my portfolio keep up with inflation even after withdrawals. I don't mind drawing the portfolio down some in my older years.

What Audrey said..... That's our plan.

No kidlets in the bbbamI household. However, I'm sure our niece and nephew will inherit at least a little something from us.

[clifp]

Quote:

Originally Posted by ERD50 Agreed, I'm scratching my head over some of these distinctions. Taxes are a factor, but other than that it's all about total returns. Anything else seems like an 'illusion' to me. A $ is a $. One can invest in dividend paying stocks, and plan to only spend the dividends. Fine, but what leads them to believe those are going to keep up with inflation? If not, you are dipping into principal. Of course I'm not saying it can't work, I just don't see where there is any inherent advantage over a total return approach with a wide mix of stocks/bonds in your AA of choice. Now, if you feel confident you have skills in picking individual stocks, maybe that means you can pick a great stable of dividend payers. But why not a stable of total return stocks? I don't get it. Maybe people are saying they will adjust spending down if divs decrease? There are other ways to skin that - stick with whatever divs you get from a wide portfolio, and take any additional out as a % of the portfolio, rather than inflation adjusted WD. -ERD50

I should say I have no problems with total return investing. In fact for the person who is primarily investing in index mutual funds I think it is superior and certainly simpler. I don't even think that dividend stock produce superior returns. Not owning Apple stock this last decade other than through index funds has certainly put a drag on my performance.

I do think that a portfolio of dividend stocks produce lower volatility returns than none dividend stocks This is in part because of the nature of dividend paying stocks, more mature, stable, and in slower growth areas. Historically dividends have more than kept up with inflation. For instance the income on IVV (SP500 index fund) rose 12.8% from 2008 to 2012 despite a significant income drops in 2009. Inflation is 6.6% over the same period. Over longer period the gap between dividend growth and inflation is even more pronounced.

As a 1999 retiree, a 4% SWR would have been devastating, even a 3.5% WR I think would have left me in panic in 2008. I didn't stumble into this strategy until around 2002/3 a few years into my retirement.

The ah ha moment came when I realized that I could construct a portfolio of stocks and bonds, that provided enough income to adequately fund my spending needs. At this point my withdrawal rate is pretty much an academic interest. The real answer to the question of how much do I withdraw each year, is "less than my dividend and interest income." Is there a guarantee that my income will keep up with inflation, no. But as long as I maintain this strategy I also know I'll never run out of money.

Now in 2009, I withdrew a bit more than I earned cause of combo of lower interest rates and my banks stock slashing dividends. But considering all the year I spent less than my income it wasn't a great concern

This year with a new expensive car, and kitchen remodel I'll be dipping into my principal. At some point when I am in my 70s or 80s I know there is a decent chance that I'll have to buy into an assisted living center and use principal for that.

[WestLake]

Won't RMDs cause dipping into the principle?

[REWahoo]

Quote:

Originally Posted by WestLake Won't RMDs cause dipping into the principle?

Not if you don't spend them - other than to pay taxes.

[pb4uski]

I saved it to be able to spend it in retirement. I've already told our kids (who we provided paid college education for) that if there is anything left that it is estimating error.

Not totally true, but I like the idea.

[HighRoller]

I have no plans to tap into my principal but I would (within reason) if I needed it to maintain my lifestyle.

[haha]

Quote:

Originally Posted by mpeirce Money is fungible.

Really?

[LakeTravis]

My strategy is nothing more than a three bucket approach:

1. First after-tax bucket in extremely conservative MF's contains enough to supply annual withdraws up until I collect SS at 62. (8 years worth of income).

2. Second after-tax bucket in somewhat conservative MF's is allowed to (hopefully) grow untouched and contains enough to supply annual withdraws for another 9 years.

3. Third bucket is my 401(k) which will be able to (hopefully) grow untouched for 17 years and by the time I'm 72 will be more money than I'd be able to responsibly spend for the rest of my years.

Firecalc gives me a 100% success rate. I'm not planning on leaving a financial legacy, but there is a good chance there will be one.

[mpeirce]

Quote:

Originally Posted by haha Really?

Money is fungible just means that money from one source is interchangeable with money from another source. Money from dividends is as a good as money from capital gains is a good as money from interest for buying bread.

Yes, there are tax implications such as capital gains taxes ranging from 0 to 20%+ vs dividend tax rates and such. That will vary a lot from person to person.

Fungible - Definition and More from the Free Merriam-Webster Dictionary

[Tree-dweller]

Quote:

Originally Posted by pb4uski I saved it to be able to spend it in retirement. I've already told our kids (who we provided paid college education for) that if there is anything left that it is estimating error. Not totally true, but I like the idea.

Same here. We paid for the kids college (private, undergrad). Any future cash endowment is based on a couple of early deaths. Otherwise, there should be just enough left over to pay for our Viking funerals.

[Tyro]

Quote:

Originally Posted by Midpack No kids, draw down principal and die broke if possible. But most likely we'll end up with some residual that will go to charity and/or nephews & nieces...

+1. In some ways, it's the trickiest plan to achieve, which is what vexes me.

[imoldernu]

Preserve Principal or Draw it down?

Our plan had to be Draw it down... or work for many more years. Now 24 years of retirement nearing age 80, it has worked better than we planned. Yes we started drawing down last year, and our earlier plan to die at age 84, has been pushed forward to about age 90. Here's our original plan that was posted here:
http://www.early-retirement.org/foru...ent-62251.html

Quote:

1. Instead of starting from what you need to retire, look at what you'll have to retire on. "Reality based planning" 2. Calculate how much income you can count on, from fixed sources. Social Security, Guaranteed Pensions, Annuities, Don't try to calculate inflation... either here or in your retirement expenses, later on. If you're planning on investment income from stocks or bonds, use a conservative ROI percentage, not the 8% that your pension fund uses. (Note: For planning purposes, don't used income compounding... this is an offset to the inflation factor that you won't be considering. Example: (use annual figures for simplicity) ..........Social Security... $22K ..........Pension........... $10K ..........Stock............. $5K ..........Pt. Time work..... $8K ..........Tot. income....... $45K 3. Spending down net worth... Calculate this, by taking your total net worth (let's say $230K) and dividing this by the number of years between your retirement date,and your currrent life expectency. Thus if you retire at 62 and your life expectency is 85, your number is 23 ... 85 -62 = 23 Now, you can spend down that at $10,000 per year. $230 / 23 = 10K 4. Your simple retirement plan would thus allow you to spend $45K + $10K or $55,000 per year. .................................................. . The obvious... What about inflation? All I can say here, is that somehow, over the past 20 years inflation and income has somehow equalized, probably due to the low CPI... but for simple, basic planning purposes, up until now, this has not affected my own plan. At the very least, whether this scenario looks right for you or not, it gives some kind of a base to build on. As stated earlier, this would be a best circumstance budget, built from the income expectations. You might consider creating a "nominal" budget, by simply not using the sell-down of assets. Of course, an austerity budget is built from the ground up... based on minimal expenses.

We're still on our "Optimal Budget"... The Nominal Budget will be when we sell our Florida home, and our Camp... (Current expenses about $18K/yr).... the "Austerity Budget" will be when we sell our current home, and move into a Continuing Care Retirement Community (One price all expenses- Meals, Apartment,Transportation, Utilities) ... currently about $27K/yr.

[samclem]

Quote:

Originally Posted by clifp The ah ha moment came when I realized that I could construct a portfolio of stocks and bonds, that provided enough income to adequately fund my spending needs. At this point my withdrawal rate is pretty much an academic interest. The real answer to the question of how much do I withdraw each year, is "less than my dividend and interest income." Is there a guarantee that my income will keep up with inflation, no. But as long as I maintain this strategy I also know I'll never run out of money.

Of course these are the same attributes of a "withdraw X% of the year end balance" approach: You'll never entirely run out of many, but
the true value of your annual "take" could erode over time if you take too much.
The graph on slide 16 of this link (sorry, I couldn't figure out how to clip it fromt he .PDF) shows me two interesting things:
1) Over time, dividend income has stayed ahead of inflation
2) There have been considerable periods when they didn't (just mentally scoot the pink line up to the blue so they touch at a particular year of interest and note how they can grow apart over time). That could mean a decade-long period of reduced standard of living in retirement while the total value of the portfolio (the stock share prices) could be climbing through the roof, way ahead of inflation. That doesn't seem optimum if we recognize we all have a finite lifespan (and an even shorter period of good health).

Other observations:
- If an investor is going to live off dividends, he'll pick stocks that pay them. These are predominantly "value" stocks, not growth stocks. The behavior of these two types of stocks are not well correlated (see Audrey's recent post with the Callan Periodic Table of Asset Classes). So, while dividends may be a smoother income source, shifting heavily to dividend-paying stocks could lead to greater annual portfolio volatility. And owning a share of growth stocks closer to their true weight in the market will help a portfolio do well in periods when the economy is booming (when dividend-payers lag), allowing rebalancing into--more dividend-paying stocks.

All that being said: Our portfolio is tilted toward value stocks and I appreciate the very important role dividends will play in our anticipated total return and in smoothing out the returns over the years. But I don't think it's optimum to shackle us to a hard rule of living just on this one type of income when we consider the real-world ramifications (likely artificially low WR in many years and leaving a big pile of money when we're dead). If I were running an endowment I'd probably feel differently.

[sheehs1]

No plans to touch principle. This year, testing the rerouting of dividends and interest from only the taxable account to my checking account in preparation for Jan 2014 after my paycheck officially stops. If my husband and I find we don't need that, I will reroute back until we are 65 which would be another 7 or 8 years.

Age 65 is when I plan to let go of my frugal ways. Maybe. Could be hard. Actually might be darn impossible.

[akck]

My plan is to draw down principle in the early years, until other resources come online. Once the house is paid off (probably going to term vs. early payoff), pensions and SS will exceed needs. My wife thinks we shouldn't spend anything in the retirement account, but that would require that we don't eat or heat the house. My argument is we'd be drawing down earnings and appreciation. We'd like to leave something for the kids, but that's not a requirement.

[FIREd]

Quote:

Originally Posted by samclem Of course these are the same attributes of a "withdraw X% of the year end balance" approach: You'll never entirely run out of many, but the true value of your annual "take" could erode over time if you take too much. The graph on slide 16 of this link (sorry, I couldn't figure out how to clip it fromt he .PDF) shows me two interesting things: 1) Over time, dividend income has stayed ahead of inflation 2) There have been considerable periods when they didn't (just mentally scoot the pink line up to the blue so they touch at a particular year of interest and note how they can grow apart over time). That could mean a decade-long period of reduced standard of living in retirement while the total value of the portfolio (the stock share prices) could be climbing through the roof, way ahead of inflation. That doesn't seem optimum if we recognize we all have a finite lifespan (and an even shorter period of good health). Other observations: - If an investor is going to live off dividends, he'll pick stocks that pay them. These are predominantly "value" stocks, not growth stocks. The behavior of these two types of stocks are not well correlated (see Audrey's recent post with the Callan Periodic Table of Asset Classes). So, while dividends may be a smoother income source, shifting heavily to dividend-paying stocks could lead to greater annual portfolio volatility. And owning a share of growth stocks closer to their true weight in the market will help a portfolio do well in periods when the economy is booming (when dividend-payers lag), allowing rebalancing into--more dividend-paying stocks. All that being said: Our portfolio is tilted toward value stocks and I appreciate the very important role dividends will play in our anticipated total return and in smoothing out the returns over the years. But I don't think it's optimum to shackle us to a hard rule of living just on this one type of income when we consider the real-world ramifications (likely artificially low WR in many years and leaving a big pile of money when we're dead). If I were running an endowment I'd probably feel differently.

I do agree that living on dividends alone is probably a sub-optimum use of my money. It could lead to some belt tightening when income dips and will likely result in a large surplus in the end. This does not bother me in the least, even though I have no kids. But this is a reflection of my own values and experience, which I do not expect to be shared by many. Different strokes for different folks, I guess.

I grew up in a country where the maximum sustainable withdrawal rate for a 30-year retirement would have been just under 1% for a balanced portfolio (based on data from 1900 to 2008). So the total return approach would have prevented most anyone in that country to retire comfortably. But income investing delivered when the market did not. And that's how people finance their retirement there - total return strategies would be seen akin to speculation. I hope that the US market continues to deliver returns that are exceptionally higher than other countries. But I do not want to bet the house on it.

Also, one can be a total return investor and live only on dividends with a low enough WR. Lots of people on this forum seem to target WRs below even the currently depressed yield of a balanced index portfolio. Usually, total return investors earn interests and dividends while income investors keep an eye on total return as well. The line between the 2 strategies is a blurry one - although it is hard to tell given the hard battle line usually drawn in this debate.

[misanman]

Our plan is to live off of dividends but would (obviously) dip into principle if we had to. A long term care scenario is an example of where that might be necessary.