4% rule.

[pb4uski]

If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

[ER Eddie]

Quote:

Originally Posted by pb4uski If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

But not necessarily longer than you wanted to.

[pb4uski]

True.

[TheWizard]

Quote:

Originally Posted by RunningBum You are taxed on dividends whether you reinvest or not. If you reinvest and then sell, you also have a sale which is a separate taxable event. If you sell the shares you just reinvested, the gain or loss should be very small. But if you're using avg cost basis, there could be a larger gain (or loss). btw, long term capital gains are taxed exactly like qualified dividends. Not "pretty close", but the same. At least on federal taxes. Likewise, short term capital gains are taxed like unqualified dividends.

The OP stated that all of their investments are in tax-deferred or Roth accounts, no taxable account presently.
So taxation of distributions is not presently relevant...

[ER Eddie]

Quote:

Originally Posted by TheWizard The OP stated that all of their investments are in tax-deferred or Roth accounts, no taxable account presently. So taxation of distributions is not presently relevant...

Ah, I missed that. But it may be relevant when she starts taking dividends out of those funds to cover her retirement expenses. Granted, that's 20 years from now...

[TheWizard]

Quote:

Originally Posted by Badger Please explain. It seems to me if you sell shares then any dividend payout will decrease because fewer shares would result in fewer dividends. But if instead you just take dividends each year then you have the same number of shares for next years dividend payout...

That depends entirely on what percentage of shares you sell.
If you sell 1-2% each year you should be good forever.
If you sell 5-6% each year you could start seeing a declining nest egg...

[audreyh1]

Quote:

Originally Posted by ER Eddie Thanks for the clarification. So, if you use the dividends rather than reinvest them, you get taxed once (which happens regardless), but if you reinvest the dividend and then sell it, you get taxed both on the dividend and the cap gains. Have dividend tax rates always been the same as cap gains rates? Or have they differed in the past?

Not always, but for a long time now.

In a taxable account, if you are smart about only selling the shares that were recently reinvested, the capital gain or loss would normally be very small.

Certainly in a tax deferred account there is no taxable difference at all.

[CRLLS]

Quote:

Originally Posted by ER Eddie Ah, I missed that. But it may be relevant when she starts taking dividends out of those funds to cover her retirement expenses. Granted, that's 20 years from now...

They are not really relevant in the OP's retirement expenses. Any money taken from her 401k is taxed as regular income, whether from cap gains or stock. The money from cap gains or stock in their Roth is not taxed at all. Taxation is indiscriminate in both cases. It is in after tax investments, which she doesn't have, where there is a difference in the way they two are taxed differently.

[CRLLS]

Quote:

Originally Posted by Safire That is only if I spend only the number of shares that my dividend reinvestment could have gotten me. If I spend more shares than what my dividends would have purchased I would soon be spending down the principle. Spending only the dividend forces me to conserve the principle. Am I getting this right? At retirement, what if I turned off dividend reinvestment option in my a/cs? That would show me what dividend my portfolio has earned and help me withdraw only that cash? Right now, I don't check what my funds are earning in dividends. That will only change when we no longer have a paycheck each month.

You can do that if you want, It certainly is fairly easy. There are other ways to find what dividends were issued. In my Fidelity monthly report I can see what the dividends are each month. It even gives me an estimated dividend over the upcoming 12 months. If you find that you don't withdraw those dividends, They are "usually" swept into a cash fund where they earn relatively next to nothing. I find that reinvesting dividends is a hands-off approach to buying more equities. YMMV.

I will comment that your posts seem to indicate you may not need the money the dividends to live on but if you do want some money from the account, you just don't want to touch the "principle". In actuality, the number of fund shares that you started with. As has been suggested many times here, there is no financial difference between reinvesting dividends, selling stocks and then withdrawing or just withdrawing dividends. If doing the latter helps you sleep better at night and helps you follow a plan, who are we to try to change your mind? It really is a horse and a horse.

[Out-to-Lunch]

Quote:

Originally Posted by pb4uski If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

+1

I made exactly this point early on, but it seems that the OP missed my point.

[Out-to-Lunch]

Quote:

Originally Posted by Safire Maybe my question should really be - how can we live off SS (assuming only 60% of the amount estimated to be our payout at retirement) & small pension to preserve the retirement a/cs for our son's trust to inherit 100%. What circumstances would make that doable / possible?

I agree, this is really the right question. The answer has nothing to do with what you do with dividends.

Your thread title was "4% Rule." Historically, this was the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have the pot of money stay above $0 for at least 30 years. This has been often referred to as the "Safe Withdrawal Rate" (SWR).

You really want to ask about the "Perpetual Withdrawal Rate" (PWR). This is the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have it last indefinitely, i.e., maintain your principal. Historically, this has been about 3.3 to 3.5%.

Again, the SWR (4%) explicitly contemplates depleting your pot of money. The PWR is designed that your pot does not decrease in the long term.

The dividend issue is a red herring. The answer to your question is simple, but not easy: You "just" need to accumulate 30 times your anticipated yearly expenses.


More reading: https://portfoliocharts.com/2016/12/...ng-retirement/

Quote:

By definition, safe withdrawal rates plan for failure. They are explicitly defined to cause you to just barely not run out of money under certain historic conditions. In contrast, perpetual withdrawal rates follow the first rule of investing — don’t lose money! These are the withdrawal rates that preserved the original inflation-adjusted principal even at the end of the single worst investing timeframe of a given duration. By weathering the storm and leaving you with the same amount of money you started with, you’re prepared not to quietly pass away with a few dollars remaining but to start all over again.

[NW-Bound]

Quote:

Originally Posted by Safire Maybe my question should really be - how can we live off SS (assuming only 60% of the amount estimated to be our payout at retirement) & small pension to preserve the retirement a/cs for our son's trust to inherit 100%. What circumstances would make that doable / possible?

The market vagaries are such that it is impossible to guarantee that you will always have 100% of your investments intact at all times, even if you withdraw 0.

Here's something in recent memory, just 13 years ago. Some people do not remember, but I do.

On 2007/10/09, the S&P was at 1565. A year and a half later, on 2009/03/09, it was at 677. That's down to 43c on the dollar (a loss of 57%). OK, if you reinvested dividend, perhaps you still had 46c on the dollar.

Over time, the market has always climbed back. Sometimes it took a couple of decades, sometimes just a couple of years. That's the nature of the beast.


PS. Is it really as bleak as what I showed above? No, it does not have to be, if you are not 100% in stock.

The link provided by Out-to-lunch above claims that with a 60/40 portfolio, you can draw 3.5% (which may be more than the dividend), and even in the worst case 10-year period, still come out with your stash at the its original value, and on an inflation-adjusted basis at that.

But the above still means that you have to be prepared to see your stash being down during that 10-year period. I am going to check to see how far a 60/40 portfolio was down. Certainly, a lot better than the 43c on the dollar recent case I showed above.

[NW-Bound]

Quote:

Originally Posted by Out-to-Lunch ... More reading: https://portfoliocharts.com/2016/12/...ng-retirement/

Quote:

Originally Posted by NW-Bound ... The link provided by Out-to-lunch above claims that with a 60/40 portfolio, you can draw 3.5% (which may be more than the dividend), and even in the worst case 10-year period, still come out with your stash at the its original value, and on an inflation-adjusted basis at that. But the above still means that you have to be prepared to see your stash being down during that 10-year period. I am going to check to see how far a 60/40 portfolio was down. Certainly, a lot better than the 43c on the dollar recent case I showed above.

I scanned through the link by Out-to-lunch too fast, and missed this important fact. No, the article did not say that the traditional 60/40 portfolio would recover even in the worst 10-year period. It was the "Golden Butterfly" that the article proposes.

This Golden Butterfly Portfolio is:

20% Total Stock Market
20% Small Cap Value
20% Long Term Bonds
20% Short Term Bonds
20% Gold

Sorry for the mistake.

The article says that the most the above portfolio lost was 11%.

Regarding the 60/40 portfolio, I checked with 2 different calculators using historical data. With a 3.5% WR, one calculator says that the lowest the portfolio got down to in a 10-year period was $414K, and the 2nd calculator says $421K.

Taken at face value, it appears that the "Golden Buttefly" porfolio has lower volatility than the traditional 60/40 portfolio. It lost less in the worst case, but I suspect that in the average case it gained less. There's always a trade off somewhere.

[Out-to-Lunch]

Quote:

Originally Posted by NW-Bound Regarding the 60/40 portfolio, I checked with 2 different calculators using historical data. With a 3.5% WR, one calculator says that the lowest the portfolio got down to in a 10-year period was $414K, and the 2nd calculator says $421K.

Yes, I agree with everything you wrote, and thanks for the clarification.

My intent was to have the OP focus on long withdrawal periods, like 50 or 60 years, which is of interest to the OP. I admit that I did not consider not ever being down over short periods; I only was thinking about not going to zero in the long run.

[NW-Bound]

Quote:

Originally Posted by Out-to-Lunch Yes, I agree with everything you wrote, and thanks for the clarification. My intent was to have the OP focus on long withdrawal periods, like 50 or 60 years, which is of interest to the OP. I admit that I did not consider not ever being down over short periods; I only was thinking about not going to zero in the long run.

After a long bull market, people tend to think they have the stomach for market volatility. Pedal to the metal. Then, in a bad market downturn, they gnash their teeth, cry their eyes out, sell low and never get back into the market.

Even on a bright sunshine day, one needs to keep in mind the gloomy days that will surely come. It's so easy for people to forget that.

I am by nature a gloomy guy, and I always look behind my shoulder. Having been through two tough market downturns, I am getting used to seeing big losses. Whether the market goes up big or drops fast, I find it exciting, and constantly ask myself what's the right thing to do.

[SevenUp]

Quote:

Originally Posted by SevenUp Taking a dividend payout for living expenses is no different than selling some shares for living expenses.

Quote:

Originally Posted by Badger Please explain. It seems to me if you sell shares then any dividend payout will decrease because fewer shares would result in fewer dividends. But if instead you just take dividends each year then you have the same number of shares for next years dividend payout.

When a dividend is paid, the share value decreases. You now have a choice between
a) taking the dividend for living expenses, or
b) reinvesting the dividend and selling shares for living expenses.

Either way you have paid your living expenses and are left with the same investment value.

[Exchme]

Let's work through one more time with numbers.

Let's take the world's simplest company. They make buggy whips but there's no profit in that, so their only asset is $3000 in the bank and they have 3000 shares issued. Each shareholder starts with 1/3 the company, 1000 shares. The company laid everyone off so has no expenses. They distribute a $60 dividend to their 3 shareholders, leaving the company with a true value of $2940, $0.98/share.

#1 reinvests his $20 dividend, #2 takes her dividend in cash and #3 takes the dividend in cash and sells 20.2 shares to #1 at $0.98/share (we need a seller for #1 to be a buyer).

Now #1 owns 1020.2 shares at $0.98/share, so still $1000, but now owns 34% of the company instead of 1/3.

#2 owns 1000 shares at $0.98/share, so $980, plus has $20 in cash, so she still has $1000 in assets and 1/3 of the company.

#3 owns 979.8 shares at $0.98, so $960 in stock, $20 cash from the dividend and $20 cash from the sale to #1, so still has $1000 in assets, but now 32.66% of the company.

So all our shareholders have to pay tax on their dividend, plus #3 has to pay any capital gains tax earned on the shares sold.

Now our company discovers that it can in fact make a bit of profit, so the stock prices rises to reflect this.

#1 feels vindicated for reinvesting as he now has a larger portion of the company, but had to pay tax on the dividend out of his cash stash.
#2 feels like this was a magic money tree where she took $20 cash out (minus taxes due) but the stock price went back up.
#3 took the $40 in cash, paid taxes on it and became a crypto millionaire, so doesn't care about owning a tiny bit less of this boring stock.

Everyone could have gotten to the same spot with less taxes due if the company had paid no dividend but did a stock buyback of $60, leaving 2940 shares at $1.
#1 does nothing. He would not pay any taxes yet and will own 34% of the company as in the dividend case.
#2 would sell $20 worth of stock to the company, ending with $20 in cash and 980 shares at $1 each. She would pay tax on any capital gains in the $20 and would still own 1/3 of the company.
#3 would sell $40 worth of stock to the company and also pay tax only on the gain and would now own 32.66% of the company.

So stock buybacks are equivalent distribution mechanisms as dividends, but more tax efficient especially for accumulators like #1. Even seller's get a bit of tax efficiency as their gains will usually be less than 100 cents of every dollar stock sold.

If the company did not do anything to distribute cash, then we need a buyer (say #4) in order for #2 and #3 to get their desired cash out.
#1 does nothing, he ends up owning 1000 shares at $1/each, 1/3 of the company (company is worth $3000 since it retained all resources).
#2 sells $20 worth to #4 and ends up with $980 in stock and $20 in cash, owning 32.66% of the company.
#3 sells $40 worth to #4 and ends at $960 in stock, $40 in cash, owning 32% of the company.
#4 paid $60 for 2% of the company.

Other than taxation, where dividends are a negative, they are completely irrelevant since the shareholder is already the owner of the company assets, but current taxes can be minimized by avoiding taxable events like dividends.

[pb4uski]

Sounds like you are unaware of the 0% tax rate for qualified dividends in long-term capital gains that a lot of us manage our income to be in

[audreyh1]

The OP had the case of a mutual fund held in tax-deferred or tax-free accounts. It simplifies things immensely as there are no tax consequences when distributions are paid in those accounts.

When a MF distribution is paid out, the value of the MF shares drop to make up the difference. If you reinvest the distribution, you end up with more shares, but the total $ value is the same.

So you have choice of preserving the total value by reinvesting the distribution, or taking the distribution in cash and have the remaining value drop by that amount. It’s very much a wash.

[ER Eddie]

Quote:

Originally Posted by Out-to-Lunch I agree, this is really the right question. The answer has nothing to do with what you do with dividends. Your thread title was "4% Rule." Historically, this was the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have the pot of money stay above $0 for at least 30 years. This has been often referred to as the "Safe Withdrawal Rate" (SWR). You really want to ask about the "Perpetual Withdrawal Rate" (PWR). This is the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have it last indefinitely, i.e., maintain your principal. Historically, this has been about 3.3 to 3.5%. Again, the SWR (4%) explicitly contemplates depleting your pot of money. The PWR is designed that your pot does not decrease in the long term. The dividend issue is a red herring.

Interesting. I'd never heard that distinction before -- PWR vs. SWR -- and had always been a bit confused about this.

So, 3.3 to 3.5% to maintain your principal. I'll have to remember that. All you ever hear about is SWR.