My concern with Cliffp's approach iare three-fold: First, it could lead you to investing in risky high-yielding investments all the while telling yourself how safe you are because 'you're only spending dividends and not touching principal'.
Second: plenty of high yielding securities, such as MLPs are actually paying you back a portion of your capital each year in that dividend -- you'll sometimes learn exactly how much because you actually get different tax treatment on the two portions and the 1099 or k1 will tell you as much. Our reptilian pleasure-seeking brains may choose to ignore all those niceties and just say, "i'm safe, since I'm only spending dividends'. The principal may even be holding steady.... until you factor in inflation. And if it does better than overall interest rated after doing all that math, it's because you're taking on extra risk-- see point 1.
An additional comment on MLP (I own several despite not recommending any in my post), you are correct that for taxes purposes a lot of the MLP distributions are treated as return of capital. Still I think it is useful to separate assets which really depreciate from those which have a far longer life with good maintenance.
A huge amount of the capital expenditure Intel builds a new chip plant is gone after a few years because the technology changes so rapidly. A shipping company may buy a new bulk shipper and depreciate over 30 years and by the end of 30 years it will worth considerable less due to high maintenance cost. In contrast most MLP own assets like pipelines which have useful lives in the 50 -100 year range. Now for tax purpose it appears like return of capital, but in reality the lifespan (and hence the economic value) of these assets exceed my own life expectancy. Last year many of these MLP were yielding 7-9%, and most have the prospect of raising distributions at least as fast as inflation. Pipelines are regulated and general rates increase at roughly inflation levels. At current yields of 6% the risk/reward ratio of most MLPs vs a 6% CD looks fairly marginal.
For this reason I look at energy MLPs as similar to TIPs or more accurately corporate inflation bonds like Sallie Mae's OSM/ISM, but with a 2-4% yield premium.
In fact, my dividend income approach asset allocation looks like this
10-35% cash and bonds (mostly government)
35-60% Stock index funds
The remainder is in "income" investments, these include high yield stock like tankers, MLPs, cover call premiums, REITs, and traditional blue chip stocks with high dividends like Bank of America. Now these "income" investments are fairly diversify group but they share some common attributes.
- An expected total return of 4-6% over T-Bills
- Much of the return comes in the form income not capital gains
- Less volatile than the overall market
- Fairly sensitive to interest rates.
There are of course risks associated with this strategy, including sector risk, and individual company risk. Probably the biggest risk is the "no home run" effect. I may ocassionally get a stock that double or triples, but I think there is no chance that an MLP, a BofA, covered call, or even a tanker stock will be the next Microsoft, Starbucks, or Google.
The upside is a more predictable income flow, with reasonable inflation protection.
