Preserve Principal or draw it down?

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.
 
I have no plans to tap into my principal but I would (within reason) if I needed it to maintain my lifestyle.
 
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.
 
pb4uski said:
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.
Click to expand...

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.
 
Midpack said:
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...
Click to expand...

+1. In some ways, it's the trickiest plan to achieve, which is what vexes me.
 
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/forums/f27/sharing-23-years-of-frugal-retirement-62251.html
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.
Click to expand...

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.
 
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clifp said:
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.
Click to expand...
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.
 
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.
 
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.
 
samclem said:
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.
Click to expand...

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.
 
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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.
 
FIREd said:
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.
Click to expand...
This is also how I see it. To me, every retired person who does not have an adequate pension /ss combo is a de facto income investor, since you must pay bills with cash, not stock. Some target this explicitly in dividends and interest, some take a % cut off the portfolio, usually with a lot of kentucky windage figured in. I happen to think that the idea that one's starting balance is a big factor is kind of strange. What if you retire with $2mm, then 2 years later a massive selloff shows you with $1mm. Which is the value that reflects earning power of the portfolio? Maybe it is quite undervalued at $1mm, but maybe it was hugely overvalued at $2mm, and the cash flows supported by the portfolio reflect a $1mm value. So do you draw $40,000 or $80,000? Pretty big swing.

It's a fairly simple problem, that has been obscured by the odd failure to consider business value, rather than nominal portfolio price.

To me, a dividend/interest focused investor is best served by careful attention to the specific vulnerabilities of his portfolio securities.

Ha
 
FIREd said:
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.
Click to expand...

The "total returns" method really does look at total returns. So if implemented in a market where dividends are the only return, then it should be investing in plenty of good dividend stocks. Dividends are definitely part of the return. That's why we search so hard for total return data that includes reinvestment of dividends, not just share prices.

On the other hand, if my nondividend stock share price goes up 10% in a year and inflation goes up by 3%, am I touching principal if I sell 5% of the shares instead of receiving a 5% dividend?
 
We plan to use principal in the long run. So far we have managed with dividends as my pensions provide 60 - 70% of the income we currently need. However they are not COLA'ed so, for us, when we start using principal depends mostly on inflation.

We have told our children not to expect much of an inheritance.
 
Animorph said:
On the other hand, if my nondividend stock share price goes up 10% in a year and inflation goes up by 3%, am I touching principal if I sell 5% of the shares instead of receiving a 5% dividend?
Click to expand...

But what if the share price is down 10% and you have to sell 6% of the shares to clear the same amount of cash? As I have said above, I am a poor judge of this because of my background. But IMO, if you have to sell something to generate cash money, you are eating into the principal. Perhaps not so much in good time. But definitely in bad times.
 
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imoldernu said:
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. :).
Click to expand...

Lol , don't you hate it when a plan doesn't come together:LOL: May you have many more years of healthy living together. Shoot for 100:)
 
FIREd said:
.... IMO, if you have to sell something to generate cash money, you are eating into the principal. ....
Click to expand...

I think one is eating into principal only if you are eating into your basis or contributions. It your are simply realizing unrealized appreciation by selling I don't view that as eating into principal.

For example, if you have some long held stock that has quadrupled in value to $400k from an initial investment of $100k and sell $100 of the $400, you are not eating into principal IMO.
 
pb4uski said:
I think one is eating into principal only if you are eating into your basis or contributions. It your are simply realizing unrealized appreciation by selling I don't view that as eating into principal.

For example, if you have some long held stock that has quadrupled in value to $400k from an initial investment of $100k and sell $100 of the $400, you are not eating into principal IMO.
Click to expand...
An investor depending on interest from a bank account for income thinks of the principal as the "goose" that lays the annual golden egg which will keep food on the table. He doesn't want to eat into principal because it will reduce available interest income for all coming years.

Along these same lines, shouldn't a dividend investor think of "principal" as the number of shares of dividend-paying stock, rather than the value of those shares? It's the shares (not their value) that throw off dividend income each year. If he sells a share (regardless of whether it has quadrupled in value or been cut in half) he has eaten into his principal. No?

Your example is a good one, and why I believe withdrawals should be based on total year-end portfolio value rather than only on the dividend component of the total return. Historically, share price appreciation accounts for about 40-50% of total return in equities (dividends are the other 50-60%). If the portfolio's value is ahead of inflation for the year after taking withdrawals, I don't believe any principal has been eroded, in a practical sense.
 
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Dividends only for me for the near future. (I have a modest pension now and SS in the future. I can live off the pension and SS when it comes. I may draw down some principal later after it has grown a bit.
 
Hmmm.... The unmentionable:
Whaddya do if the market tanks and the DJIA goes to $6000? Ride it down... gracefully? Get out before it happens, like 100% of all investors? Wait it out?

Hey! that was a joke.... :dance::LOL::facepalm:





:flowers:
 
pb4uski said:
I think one is eating into principal only if you are eating into your basis or contributions. It your are simply realizing unrealized appreciation by selling I don't view that as eating into principal.

For example, if you have some long held stock that has quadrupled in value to $400k from an initial investment of $100k and sell $100 of the $400, you are not eating into principal IMO.
Click to expand...

I think that fits better if you are selling the gain that is excess over inflation. But as haha points out, that portfolio can drop, and maybe now it isn't beating inflation, then what did you do? Does it really matter?

But if we are shooting for a conservative WR, say 3~3.5%, and a 75% stock AA is kicking off 2% or more, there isn't that much selling to be done. You can pull out a percent or two now and then as part of rebalancing.

I think a low 3% WR is conservative enough for me. While I suspect the future economy will not be as bright as what is in the past, I doubt that it will be worse than the worst of the past. That's why I like a 100% success rate in FIRECALC. And if it is worse, we will all be in that boat together, most of us didn't get to FIRE w/o being able to plan and adapt, so we'll be (relatively) fine. What else can you do?

-ERD50
 
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