Preserve Principal or draw it down?

[haha]

Quote:

Originally Posted by FIREd 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.

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

[Animorph]

Quote:

Originally Posted by FIREd 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.

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?

[Alan]

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.

[FIREd]

Quote:

Originally Posted by Animorph 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?

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.

[UserRequested]

Quote:

Originally Posted by 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. .

Lol , don't you hate it when a plan doesn't come together May you have many more years of healthy living together. Shoot for 100

[pb4uski]

Quote:

Originally Posted by FIREd .... IMO, if you have to sell something to generate cash money, you are eating into the principal. ....

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.

[samclem]

Quote:

Originally Posted by pb4uski 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.

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.

[Lazarus]

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.

[imoldernu]

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....

[ERD50]

Quote:

Originally Posted by pb4uski 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.

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

[pb4uski]

Quote:

Originally Posted by samclem .....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?....

No, he has not eaten into his "principal" because his expectation is that his return will come from both dividends and appreciation rather than just interest.

Using your framework if an investor invests $100 in a CD that grows to $105 and takes $5 out then he has not invaded principal, but if the same investor buys 100 shares of stock for $10 that appreciates to $105 and he sells $5 worth of stock then he has invaded principal. That just doesn't make sense. Under my construct, neither investor would invade principal until they take cash out that reduces their balance to below $100.

As a total return investor, I'm indifferent as to whether my return is in dividends or appreciation - especially since they are both taxed at preferential rates (0% in my case).

[Bikerdude]

I spend dividends and interest only....except when I don't.

[rayvt]

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.

+1

We've already told our kids that they shouldn't expect an inheritance other than a BMW convertible that is wrapped around a tree.

[Lisa99]

We'll definitely spend principal. In the way it's modeled right now, we'll exhaust our after tax investment account about 10 years into retirement. But there is no choice since we have one tiny pension and will be living off of our investments for a decade before drawing social security. If something is left for our son that would be nice but its not a factor in our planning.

[Animorph]

Quote:

Originally Posted by FIREd 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.

When the dividend payer gives you 6%, their share price will go down 6%, plus down hopefully something less than 10% on its growth prospects. If the total return is the same for both stocks, you get the same amount of cash and have the same value in shares in either case.

[UserRequested]

Quote:

Originally Posted by Animorph When the dividend payer gives you 6%, their share price will go down 6% ...

That's assuming the company has no real growth potential. Investing in a company like that will result in your principal being eroded over time.

[Independent]

I'm thinking that our real net worth will be lower when the last one of us dies than it was when we retired.

It's possible that our nominal net worth will be about the same.

Both of those statements depend on a lot of unknowables.

[W2R]

Quote:

Originally Posted by imoldernu 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....

Didn't we just do this a few years ago? I think we all managed OK.

[FIREd]

Quote:

Originally Posted by W2R Didn't we just do this a few years ago? I think we all managed OK.

Just say the wh**** word and let's see how we fare this time around...

[W2R]

Quote:

Originally Posted by FIREd Just say the wh**** word and let's see how we fare this time around...

Hey, I already did, a few days ago, but it didn't seem to work. The market just keeps climbing and climbing. Maybe we each have only one effective "Wheee!!!" in our lives.