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WR vs dividend yield
Old 01-06-2016, 11:54 AM   #1
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WR vs dividend yield

So for the last several years, my dividend/capital gains have been roughly 4.5% of my portfolio. I'm 43 (investments still 90/10) and I've seen many posts where people advise not to take out more than 3% at my age. However, I'm wondering if it makes any difference in people's opinions if the yield is so high.

ie Are WR recommendations impacted by yield? I see lots of posts of people solely living off their dividends and capital gains, but if I'm going to take only 3% that means I will need to keep re-investing, not a bad thing, but curious if maybe I'm being too conservative.

Right now I'm not taking anything out as I'm still living off my house proceeds but that will run out in 4-5 years and then I'll be looking to live off my investments.
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Old 01-06-2016, 12:13 PM   #2
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ie Are WR recommendations impacted by yield?
Clarification required: For your stocks, are you talking about "Dividend Yield" or "Cost Yield"? The Cost Yield includes the change in price of the underlying security as well as the dividend, the Dividend Yield only counts the divided. From your post, it look like you are talking about Cost Yield.

Usually WR recommendations are not directly impacted by current dividend yield. If we look at, for example, how FIRECalc works, the return on equities is the total return (stock price appreciation + dividends), so the periods of high and low dividend yield are already "baked in" to the calculations. The Trinity study, etc all used the total return on equities, and so dividends are included in their calcs already--you can't take a "bonus" when yields are high without some offsetting reduction elsewhere.

In a nutshell:
- If you are a "total return" investor, then you'd ignore the dividends and just take your withdrawal percentage (whether you are using a "starting amount adjusted for inflation" or a "% of every year-end value").
- If you intend to live on dividends/interest, you can do that, too. If your stocks are typical and widely diversified, then you surely aren't getting 4.5% dividend yield on them--more like 2% today. So, you'd need to decide if you can live on that. If you take no other steps and only live on dividends and interest then you'll leave all your principle untouched for someone else to enjoy.

If a person were to withdraw the Cost Yield from their portfolio every year, they'd need to take all their dividends and also sell shares so that the dollar amount of their holdings remained constant. As you can tell, they'd be losing ground every year to inflation--They'd have a $100K portfolio today and it would still be worth $100K in 30 years--but due to inflation of those dollars, it would be worth far less in real terms.
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Old 01-06-2016, 12:30 PM   #3
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It makes a difference in the sense that your portfolio may be diverging substantionally from what most withdrawal studies assume -- which is typically something like S&P 500 for the equity portion. The S&P 500 has a dividend yield of around 2% so you are running twice that.

So the question is whether your portfolio is different enough that the study results no longer apply. Perhaps your portfolio will do better in fluctuations because you have low beta stocks (with high yield). Or perhaps you'll have more sequence of returns risk because you have very volatile stocks (which are now extremely beaten down to give you high yield). Or it may be that the differences are minor. I don't know and probably nobody does without doing a study.

I suppose you could run a historical correlation of your portfolio with S&P 500 and see how much the results differ -- if they are clearly different you might want to exercise caution. You can also check things like past variability, performances in bear markets, etc to see if your portfolio behaves similarly.

Another thing to do might be to compute the expected return of your portfolio (e.g. the way some experts do using CAPE10 and/or the dividend discount model) and compare to US historical returns (assumed by most withdrawal studies) and current expected returns.
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Old 01-06-2016, 01:16 PM   #4
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Clarification required: For your stocks, are you talking about "Dividend Yield" or "Cost Yield". The Cost Yield includes the change in price of the underlying security as well as the dividend, the Dividend Yield only counts the divided. From your post, it look like you are talking about Cost Yield.

.
If I have $1M today, I received $45,000 in dividends (4.5%) in 2015. I bought a lot of individual beaten up blue chip stocks when the market crashed in 2008... those stocks are returning far beyond 10% if I'm only looking at cost basis.

I think the different way I need to think about it is these stocks are less risk adverse, thus even though I get higher dividends, the upside/downside isn't as much, so total return is mostly made up of dividend, so I should factor that into my calculations or change my portfolio.
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Old 01-06-2016, 01:18 PM   #5
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ie Are WR recommendations impacted by yield? I see lots of posts of people solely living off their dividends and capital gains, but if I'm going to take only 3% that means I will need to keep re-investing, not a bad thing, but curious if maybe I'm being too conservative.
I'm one of those whose annual withdrawals are less than my dividends and I state that now and then on the forum. BUT - - at heart I am still a total return investor. The reason I say that, is that if my dividends should drop to, say, 0.5%, I would withdraw more than that. If my dividends rose to 5% (not likely! ), I would not withdraw that much either.

I don't think withdrawal should be impacted by yield, at least not for me. My portfolio is a fairly standard index fund portfolio supplemented with 30% Wellesley.
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Old 01-06-2016, 02:05 PM   #6
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I'd be careful to distinguish between capital gains and dividends. You want to live off dividend income. Capital gains are somewhat arbitrary, can be important to match inflation, and are not exactly income.
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Old 01-06-2016, 02:22 PM   #7
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I think that you should be careful not to let your spending be guided by your dividend and capital gain income. Your SWR should guide your spending, not your portfolio's income IMO. If FIREcalc says that you should keep your withdrawal rate below 3% for instance, I would not spend more than that even if your portfolio yielded 4.5% in dividend and capital gain income.

I plan to live on the dividend income from my broadly diversified index fund portfolio, so my withdrawal rate will be equal to the yield of my portfolio. But in this case the yield is below the withdrawal rate that FIREcalc deems safe for me. And I do plan to reinvest all capital gains.
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Old 01-06-2016, 02:36 PM   #8
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I get the original question as it relates to my own personal experience.

Meaning, I took dividends AND capital gains distributions last year as deposits to my money market account. In total, they accounted for about 3.5% of my portfolio.

But I allocated half of the CG distributions to 2016, and along with expected 2016 dividends I'll be right at my target WR of 3%. I had originally intended to allocate the other half of the CG distributions to my 2017 WR but instead I reinvested them this week into Wellington since everything is down so much.

Meanwhile, I've set my CG distributions to "Reinvest" and left Dividends to "Payout" and will go thru the same calculations/exercise next December. If there aren't any CG distributions, I'll have to sell some shares in 2017.

So I guess in my case, spending money (WR) comes from Dividends first, then CG Distributions, then Sales of Shares. Should the first two provide more than my WR for a given year, I either reinvest the surplus or keep it as cash and allocate it for the next year.
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Old 01-06-2016, 02:43 PM   #9
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Originally Posted by karen1972 View Post
If I have $1M today, I received $45,000 in dividends (4.5%) in 2015. I bought a lot of individual beaten up blue chip stocks when the market crashed in 2008... those stocks are returning far beyond 10% if I'm only looking at cost basis.

I think the different way I need to think about it is these stocks are less risk adverse, thus even though I get higher dividends, the upside/downside isn't as much, so total return is mostly made up of dividend, so I should factor that into my calculations or change my portfolio.
I think you are using the unqualified "yield" term in a confusing and non-standard manner. Most investors discussing "yield" and withdrawal rates would use the "current yield" (using the current share price as the denominator). This would be the yield figure used in withdrawal studies discussed frequently here.
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Old 01-06-2016, 03:21 PM   #10
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I think you are using the unqualified "yield" term in a confusing and non-standard manner. Most investors discussing "yield" and withdrawal rates would use the "current yield" (using the current share price as the denominator). This would be the yield figure used in withdrawal studies discussed frequently here.
Understood my example was really just an illustration vs. actual math.
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Old 01-06-2016, 03:42 PM   #11
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I generally only spend dividends and my current yield is about 3.9%. This works out pretty well. My portfolio is less diversified than many would like. At some point I will spend some principal to prevent leaving too much to heirs
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Old 01-06-2016, 04:02 PM   #12
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WR recommendations are based on total historical return, so it does not matter if it is dividends, cap gain distribution, straight cap gain, interest, etc. If your distributions are higher than your WR, then reinvest them. You need to do that in part to keep up with inflation.
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Old 01-06-2016, 05:10 PM   #13
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Understood my example was really just an illustration vs. actual math.

Karen, your illustration math is just fine by me. In fact, that is what I use and will only use.... If I put a 100k in something, and I am getting $6500 every year, my yield is 6.5% to me every year, no matter what the price of the issue is... I don't think people who buy 5-10 year brokered CDs that adjust daily in price, change what they say their yield ever is. Anything I reinvest at a different price will then have its own yield.


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Old 01-06-2016, 05:15 PM   #14
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"Are WR recommendations impacted by yield?"

If you're referring to what FIREcalc and other similar calculators use or things like the trinity study. No. It's not.

Those types of tools aggregate all returns and look at different time intervals to calculate historic survival rate.

If you use dividends returns over time to calculate WR... The yes it is effected .

I haven't seen a tool that does what FIREcalc does to see what happens if you just spend dividends every year as income. My guess is you would see more fluctuation as it's one of many elemenets in the total return of investments.

In some ways it's somewhat arbitrary since things like tax policy, lending rates, etc can make companies change how they pay dividends. For example I could tie my withdrawal rate to share buybacks or net profit or free cash flow or whatever. Dividends seem more real because you get them tangibly every quarter or so... Whereas buybacks and free cash flow you don't.

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Old 01-06-2016, 05:20 PM   #15
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My biggest concern in thinking about it this way is that it would impact my asset allocation in a yield chasing way... I.e. invisible risk.

If I know I'm spending, say 3%,.then my asset allocation exercise is "neutral." If I know I'm spending dividends income then stuff that pays higher dividends looks "more attractive." I personally wouldn't want my asset allocation brain exercise to be influenced by a single data point too much and I don't think I'd have the mental discipline to separate the two.

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Old 01-07-2016, 02:22 AM   #16
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My biggest concern in thinking about it this way is that it would impact my asset allocation in a yield chasing way... I.e. invisible risk.

If I know I'm spending, say 3%,.then my asset allocation exercise is "neutral." If I know I'm spending dividends income then stuff that pays higher dividends looks "more attractive." I personally wouldn't want my asset allocation brain exercise to be influenced by a single data point too much and I don't think I'd have the mental discipline to separate the two.

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An income approach may very well cause you to chase yield. This is why I specifically target my portfolio yield to remain at or under 4%. Obviously a bad market can push the yield up but this doesn't worry me as much as a conscious stretch for higher yield. Does take some discipline.
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Old 01-07-2016, 06:48 AM   #17
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The thing is, at age 43 you have 40+ years ahead of you.

In your case, inflation is your greatest enemy. I'd consider reinvesting anything over the 3% for another decade or so and see where things sit then.
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