Stop Stop Scrounging for Income and Sell Some Stocks

[clifp]

I am very much in the income approach camp vs total return investing. This is especially true for those retiring 55 or earlier. Never the less I find myself agreeing with much of what M* Christina Benz is saying in her latest article.

You're retired, and you have two choices to generate the money you need for living expenses. The first entails taking more risk, and the second actually reduces risk in your portfolio.

The right answer seems obvious: For the same return? Heck yeah I'll take some risk off the table.
But taking on more risk, not less, is exactly what many income-focused retirees seem to be doing with their portfolios right now. Meanwhile, a safer way to harvest income from their portfolios is hiding in plain sight: lightening up on stocks through rebalancing and harvesting the proceeds for living expenses....


There's a lot to like about income; on that we can all agree. Who doesn't like a bird in the hand? In the wake of multiple financial scandals and crises that have punctuated the past 15 years, it's not surprising that many investors are still in "show me the money" mode. Focusing on securities with the ability to pay income adds a valuable quality overlay to a portfolio, too, as income production can be an important show of an entity's financial wherewithal. From a practical standpoint, income can also provide a cushion on the downside when the market is falling, and extracting income from a portfolio during retirement is logistically simpler than managing a portfolio for total return and periodically selling off winners. And of course, income has historically been a huge component of the market's total return.
Yet some of investors' recent preferences make me concerned that they're gunning from income while neglecting total return--income plus capital appreciation or minus capital losses. Our asset-flows data show that investors have been shunning high-quality bonds, with their still-meager yields and their perceived vulnerability to rising rates. Meanwhile, yield-rich(er) bond categories have been feeling the love. The bank-loan group is by far Morningstar's top asset-gathering category so far in 2013, but yield-rich categories like high-yield bond, emerging-markets bond, and world bond have also been garnering new investor dollars during the past year. Dividend-rich equities and dividend-focused funds have been similarly popular.

While in the past I've been pretty obsessed about purchasing good dividend stocks or MLPs (except for Berkshire) lately with the appreciation of dividend stocks to really high levels I find myself more willing to sell stocks to fund things like home improvement projects and retire home equity loans.

 

[audreyh1]

I'm a total return investor, and fund my withdrawal as part of rebalancing so after a big equity run it's all coming out of stocks.

Happens naturally anyway - equity mutual funds are paying big cap gains distributions this year, and I take all distributions as cash anyway to fund my withdrawal, and then rebalance what is left over. Looks like I'll still have to trim stock funds even after the distributions are paid out.

 

[pb4uski]

+1

 

[brewer12345]

I think income chasing is foolish, but it is especially dangerous in the current environment.

 

[Chuckanut]

Diversification. Don't let your money leave home without it.

 

[NW-Bound]

I have been selling, I have been selling. Got a 6-figure cap gain this year too.

However, it is mostly in tax-deferred accounts, so no tax dues. I cannot call it "income" either until I withdraw it.

 

[Zathras]

There is a difference between "chasing income" and "chasing high-yield bonds".
We all chase income to some point or another, the question is whether you're taking on too much risk for the income you are getting.

A good level of diversification and not taking on too much risk is critical in retirement in my opinion. Personal comfort levels and length of expected retirement play big roles in how much risk you can take on.

 

[Animorph]

I can understand the income thing to some extent, and it's practically written into law for some trusts, where someone can have the income but not the principal. I think ours is even like that!

But really, I can sell some shares without somehow blowing through the whole portfolio in a year. I can sell some shares and the portfolio can still grow at the same time. I'm not spending it down just by selling shares. And back before qualified dividends it was cheaper tax-wise to have LTCG's instead of dividends. So I can invest for total return and not skew towards income at the expense of return.

 

[Running_Man]

Interesting as I review 2013 that the small dogs of the dow (T,PFE, HP, GE, INTC) for 2013 are up a total of 38.1 percent at this point with T being the worst performer at up 7.1 percent and HP the top at 99 percent up.

An interesting take on this theory is the ETF SDOG which applies the Dogs of the Dow theory onto the S&P 500 by taking the 5 highest yielding stocks of each of the S&P 500 10 sectors. This is up 28.05% YTD with an additional 3.5% payout from dividend as well for a net 31.55% The S&P 500 ETF IVV is up 28.2% YTD with a lower dividend payout of 1.8%.

Other than rebalancing to a planned level, I don't know that current levels are necessarily so high that a reduction in stock allocation is really needed.

 

[ERD50]

I just can't understand the distinction between investing for 'income' or investing for 'total return'.

It's all money, and 'total return' captures all of it.

-ERD50

 

[ShortInSeattle]

I just can't understand the distinction between investing for 'income' or investing for 'total return'.

It's all money, and 'total return' captures all of it.

-ERD50

Yeah, I'm right there with you. Is selling some shares for your withdrawal somehow BAD compared to using only dividends for withdrawal?

I suppose the former leaves you with fewer shares, but it's SWR, not S "dividend" WR. We all know the S is an exaggeration anyway.

 

[audreyh1]

I just can't understand the distinction between investing for 'income' or investing for 'total return'.

It's all money, and 'total return' captures all of it.

-ERD50

For some investors living off their investments, principal (whatever that means) is "sacred".

 

[nvestysly]

For some investors living off their investments, principal (whatever that means) is "sacred".

I generally consider DW and myself to be income investors because we focus on dividend paying stocks and ETF's. However, we don't hesitate to sell/trim positions when we have capital gains to harvest. I guess that puts us into the total return camp to some degree. Regardless, the amount of money in our "squirrel holes," as DW calls them, is much higher than the amount we contributed over the years. So I don't feel like we're cutting into principal.

On the other hand, I spoke to a friend recently and he implied that he did not want to "spend" any of his principle - only the dividends. In my mind, it's all my money so I'll spend it as needed.

Back when DW and I were accumulating wealth the dividends remained in the accounts and grew with dividend reinvestment or the dividends were allowed to go into the cash account and then more stocks/funds were purchased. So it quickly becomes difficult to tell which holdings are principle and which are not.

 

[pb4uski]

For some investors living off their investments, principal (whatever that means) is "sacred".

I know many people are so reluctant to use principal, but I figure that I saved it to be able to later spend it, not to hoard it and pass it on.

I've already told DD and DS that if there is anything left for them it is estimating error on my part. This isn't totally true as I expect there will be a sizable estate, in part because I am conservative in my planning, but I want to set expectations in case things go sideways.

 

[Danmar]

This is an issue I have been thinking about a fair bit. I am an income investor and have only spent pensions and portfolio divs since retirement. This was pretty easy because of large employee option cash outs during the 5 years after retirement. Now that all the options are gone spending is a little more constrained. But divs still growing by double digits so not a big issue. Portfolio has appreciated nicely, as you would expect. Current yield about 3.6%. I think my plan would be to gradually over time liquidate fairly small amounts(maybe $50-100k) to give us a little more spending room or top up our cash balances when markets are up. daughter will still get a very large inheritance whatever we do. Great problem to have.

 

[ERD50]

For some investors living off their investments, principal (whatever that means) is "sacred".

Yes, I understand some people think that way, and I can see where it comes from (a sense of security).

But to really do this, one should consider inflation, no? They are fooling themselves otherwise. So if you experience a year of 5% inflation, and your investments kicked off 4%, you shouldn't take anything, or you are effectively dipping into principal, right?

But they would take their 4%. But in a year of zero inflation, but only 2% divs, they would only take 2%? In the second case, their buying power increased, but they take less (assume zero growth for each for simplicity). Not sensible.

That principal's value is clearly affected by inflation. That is a huge variable for retirees. You can't just ignore it.

-ERD50

 

[MooreBonds]

This is an issue I have been thinking about a fair bit. I am an income investor and have only spent pensions and portfolio divs since retirement. This was pretty easy because of large employee option cash outs during the 5 years after retirement. Now that all the options are gone spending is a little more constrained. But divs still growing by double digits so not a big issue. Portfolio has appreciated nicely, as you would expect. Current yield about 3.6%. I think my plan would be to gradually over time liquidate fairly small amounts(maybe $50-100k) to give us a little more spending room or top up our cash balances when markets are up. daughter will still get a very large inheritance whatever we do. Great problem to have.

I also plan to live off of dividends when the time comes for retirement, but I don't have a pension to supplement things. My current overall portfolio yield is 4%, with some growth from lower yielding equity ETFs. If there are some years with larger gains like this year in the future, I'd sell off some of my equity stake and transfer it to fixed income holdings (CDs, I-bonds, preferred stocks) and spend a little bit.

 

[audreyh1]

I know many people are so reluctant to use principal, but I figure that I saved it to be able to later spend it, not to hoard it and pass it on.

I've already told DD and DS that if there is anything left for them it is estimating error on my part. This isn't totally true as I expect there will be a sizable estate, in part because I am conservative in my planning, but I want to set expectations in case things go sideways.

That was what was so cool for me when I first read about the Trinity study and SWR - it took spending down the portfolio into account. I never intended to treat my portfolio as an "endowment" so it was great to read about models for inflation-adjust portfolio survival over various scenarios.

 

[audreyh1]

Yes, I understand some people think that way, and I can see where it comes from (a sense of security).

But to really do this, one should consider inflation, no? They are fooling themselves otherwise. So if you experience a year of 5% inflation, and your investments kicked off 4%, you shouldn't take anything, or you are effectively dipping into principal, right?

But they would take their 4%. But in a year of zero inflation, but only 2% divs, they would only take 2%? In the second case, their buying power increased, but they take less (assume zero growth for each for simplicity). Not sensible.

That principal's value is clearly affected by inflation. That is a huge variable for retirees. You can't just ignore it.

-ERD50

Yep - that always gets me too. But I think a lot of folks want to buy funds/stocks, never actually sell anything, but live off the distributions.

If you are truly going to keep your principal intact, then you have to let it grow to keep up with inflation. This can mean you end up with a really low withdrawal rate to accomplish that preservation.

And then what are you going to do if your portfolio loses value due to a nasty event - like bond fund NAVs dropping due to rising interest rates? Do you just ignore it since you are not "selling any shares"? But your principal did just get hit.

And if you receive capital gains distributions - do you reinvest them? Do you not "count" them as part of the principal? Here you have to figure out how much needs to be reinvested to "preserve the principal".

 

[Running_Man]

Yes, I understand some people think that way, and I can see where it comes from (a sense of security).

But to really do this, one should consider inflation, no? They are fooling themselves otherwise. So if you experience a year of 5% inflation, and your investments kicked off 4%, you shouldn't take anything, or you are effectively dipping into principal, right?

But they would take their 4%. But in a year of zero inflation, but only 2% divs, they would only take 2%? In the second case, their buying power increased, but they take less (assume zero growth for each for simplicity). Not sensible.

That principal's value is clearly affected by inflation. That is a huge variable for retirees. You can't just ignore it.

-ERD50

In general, I am assuming that as retirement goes forward for an income investor the dividends from the stocks they purchased would increase at a rate faster than inflation.

In my case one of my goals is to select a total portfolio of stocks over the long term that are growing their dividends at twice the inflation rate, in order to fully offset the lack of increase in the bond portion of my portfolio. Overall my stocks increased dividends by 7% in 2012 and even more in 2013 due to companies such as VFC, MO and MMP (VFC raised dividend 21% in 2013 and 16% for MMP, and 9.1 % for MO) while my total portfolio dividend yield for my stocks remains in the neighborhood of 4%.

For instance I purchased VFC when the dividend was 3% because I valued the company for its exposure and growth from China, great brands and commitment to investors with its dividend and thought the dividend would grow long term by 11 percent. Since then the dividend has grown by about 14 percent but the stock as zoomed to the point where the dividend is now only 1.7% yield. Still I would not sell as it still meets my holding requirements.

The reason I prefer this logic of investing is because the companies I invest in have a clear dividend strategy for the most part and the stock price does not directly effect their plans for dividends, nor my planning for available income. The goal is to avoid the stocks that have economic factors coming that could impair their ability to pay dividend increases.

The acorn of the idea of this type of investing from me was in reading Benjamin Graham. One of his rules for investing is to invest in companies that paid a dividend of at least 2/3 of the AAA Corporate Bond (currently about 4.7 percent yielding a requirement of 3.1 percent). This is one of his rules that I have modified and found very helpful in selecting stocks, but it is certainly not the only rule to use.

This does no mean any other method of investing is better or worse, only that I have found this to work very well for the way I think about investing and it is important to be able to invest in an intellectual manner in which one is comfortable.

 

[Chuckanut]

FWIW, the legendary John Templeton when asked about investing for income or growth on WSW with Luis Rukeyser, advised people to invest for growth and sell some of the growth as needed.

Personally, I have a bias for growth, but I also have some income producing assets. As much as I admire Sir John, I admire diversification even more.

That said, if a person is an income/dividend investor and it works for him, and he sleeps well at night, who am I to argue?

 

[rescueme]

FWIW, the legendary John Templeton when asked about investing for income or growth on WSW with Luis Rukeyser, advised people to invest for growth and sell some of the growth as needed.

Exactly.

What's the difference if I "bank" a distribution or sell shares that have been purchased with that distribution, in the future?

Sure, you have market risk but than again there is risk in any decision made.

I retired May 1, 2007 - some 80 months ago. I have no pension nor am I drawing SS (even though I will be FRA age the week after next). My expenses have been met primarily with the proceeds of my portfolio with conversions to cash as conditions meet my criteria for doing so.

Is my portfolio down from day 1 of my retirement? Sure. When you are in the 25% FIT bracket (gives an idea of my retirement budget/expenses), it dosen't take much to reduce that retirement portfolio.

OTOH, I've only reduced my portfolio value (on average) less than $5k/year since my retirement. In four years (when I start SS) my annual income will increase by just over $40k/year, so I'm not really worried about my current reduction in assets and how it will affect my long term financial future.

FWIW...

 

[ERhoosier]

I think income chasing is foolish, but it is especially dangerous in the current environment.

"Chasing" income is foolish in any market. IMHO- Those who make real $$ on highest dividend stocks are generally not income chasers but traders looking to exploit short term market fluctuations. A hi-risk game.

But "chasing" is not same as investing in stable companies with dividends well-covered by ongoing profit (i.e. comfortable pay-out ratio). As we all know, dividends have been an important part of total long-term returns of equities. Many have done very well by stocking up (pun-intended ) on solid companies yielding >4% just after '08 crash.

 

[youbet]

it quickly becomes difficult to tell which holdings are principle and which are not.

And differentiating between "original principle" and "saved earnings" can be an impediment to investing efficiency. It's a illusionary distinction that hinders good investment decision making, IMHO.

A buck is a buck. Whether it was part of your RE portfolio on the day you last worked or whether it came from some investment earning is moot at the current point in time.

 

[brewer12345]

"Chasing" income is foolish in any market. IMHO- Those who make real $$ on highest dividend stocks are generally not income chasers but traders looking to exploit short term market fluctuations. A hi-risk game.

But "chasing" is not same as investing in stable companies with dividends well-covered by ongoing profit (i.e. comfortable pay-out ratio). As we all know, dividends have been an important part of total long-term returns of equities. Many have done very well by stocking up (pun-intended ) on solid companies yielding >4% just after '08 crash.

Fair enough, yet I see examples of dopey yield chasing all over the place. High yield bonds have an ocean of money running after them despite the lowest spreads and loosest covenants in years (think credit bubble proportions). Preferreds offer piddling little yields despite the huge risks they pose. Every stock with a dividend yield much above the indicies has a wall of money pouring into it. None of this looks like a market where investors (and I use that term loosely) are exercising much discretion.