Stop Stop Scrounging for Income and Sell Some Stocks

[haha]

But there are dividend based funds/ETFs. I think those would make a better comparison to a 'couch potato' style investment. How have those done versus 'couch potato'?

Logic tells me that if one group of equities was consistently better than another, money would flow into those, driving prices up an equalizing everything. Fund managers would only buy these stocks, and we'd all share in the wealth until it was arb'd out.

You might get there with individual picks, but that is hard to duplicate.

-ERD50

Can you observe all the stupid behavior in markets and still believe in this? People will do whatever dumb thing they have been convinced is good, and they never learn. (Thank heavens!)

Here's a quote from James Montier, of GMO "Never underestimate the willingness of people to believe the most outlandish things if it suits them".

Ha

 

[NW-Bound]

The market may be efficient, meaning that it reacts instantly to news, but it can be highly irrational in the short term. Short here may be a few months, or even a few years.

How else does one explain the dot-com bubble, and the recent housing bust, let alone numerous past bubbles in history?

 

[misanman]

It helps me to sleep well at night knowing that my dividend stocks have increased their dividend each year for decades. I suppose there may well be a better way to invest but the idea of having an increasing income stream that I can live on and that has demonstrated resilience over many years appeals to me.

 

[Chris M]

Where I invest (Canada) it is not difficult to get a fairly well diversified portfolio yielding in the 3.5% range. Banks, insurance, telcos, pipes, and utilities all pay in this range. Virtually no cuts in 2008-2009. Dividend ETF's would pay less mostly because of their fees. Seems to me if you can live on your divs, (I know, big if) the chance of ever running out is virtually zero. The fact that my divs have grown by 40% since 2008 make living on them a lot easier.

Maybe the Canadian financial sector dodged the bullet in 2008-09--but for many countries a portfolio overweighted towards banks, insurance and other high-dividend financial sector stocks (e.g., REITs) would have taken a very big hit. After all, it was companies like Lehman Brothers, Bear Stearns and AIG that were at the center of the storm.

I think this may highlight a key issue with a high-dividend strategy. High dividends are sometimes used as a proxy for identifying value stocks. And while value stocks have often exhibited lower volatility and higher total returns than growth stocks, there are some efficient market proponents who argue the higher returns come with hidden risks. One risk they point to is leverage--value companies tend to rely more heavily on debt financing. While any hidden risks posed by leverage may not show up in your average, run-of-the-mill bear market, a credit crunch, such as occurred in 2008, may bring these risks to the surface as debt-laden companies find it difficult or impossible to refinance. In the 1929-32 Crash--the last time the U.S. experienced a credit crisis like 2008--U.S. value stocks did significantly worse than growth stocks.

I think it's always best to focus first and foremost on managing risk through diversification. A strategy based on maximizing or optimizing dividends could expose you to risks that rarely come to the surface--except in the worst market crashes (the ones accompanied by financial crises).

 

[Running_Man]

I believe I look at a portfolio differently than many do. I do look at my portfolio from an income perspective, and have spent the last several years from 2009 preparing for my retirement which is looking like this:

$XX,XXX is the same value multiplied by the number in front of it, so if XX,XXX = $99,000 then 6.00$XX,XXX equals $594,000, actual value of $XX,XXX is different.

1.00$XX,XXX per year drawn down for 35 yrs - ladder of 5 year treasuries
1.00$XX,XXX per year in income from 30 year treasuries.
1.00$XX,XXX per year in dividends from stocks.
1.00$XX,XXX per year in non-cola pension (will only spend 1/2 at start)
0.67$XX,XXX per year DW SS
1.33$XX,XXX per year my SS @ 62 (but will prob take @ 70)
--------------------------------------
6.00$XX,XXX per year in retirement pretax available

3.33$XX,XXX per year desired retirement posttax spending

Other Assets:

5.0$XX,XXX Emergency Fund 10 year Treasury Ladder (in formation)
12.0$XX,XXX Home value - no mortgage
13.0$XX,XXX Precious Metals on deposit overseas

In this scenario does the overall value of my portfolio matter? Overall it is a conservative portfolio that will increase in proportion to stocks over time, but as time goes forward that should be acceptable as the reserves and short term treasuries have less time to insure. I have modified Harry Browne's investment ideas to an income perspective. I would sell some stocks and purchase bonds and or 5 year treasuries if the stock dividend income grew much greater than the the bond or treasury income, but the market value of the stocks, bonds in relation is irrelevant to me.

Market value fluctuations themselves will have no influence on my plan and I would not sell dividend stocks just because they have been doing well and now is the time to take those types of investments off the table.

 

[ERD50]

Can you observe all the stupid behavior in markets and still believe in this? People will do whatever dumb thing they have been convinced is good, and they never learn. (Thank heavens!)

Here's a quote from James Montier, of GMO "Never underestimate the willingness of people to believe the most outlandish things if it suits them".

Ha

As NW-Bound responded - I'm talking about long term, 30 year plus retirements, not some bubble action that comes and goes.

And again, looking at DVY, it didn't seem to act much differently than SPY in the recent roller coasters.

-ERD50

 

[haha]

As NW-Bound responded - I'm talking about long term, 30 year plus retirements, not some bubble action that comes and goes.

And again, looking at DVY, it didn't seem to act much differently than SPY in the recent roller coasters.

-ERD50

Oh, I am not trying to make a case that dividend stocks are less likely to be pushed around irrationally than other stocks. I think this may be the case in some times of extreme market behavior, but not all. I wouldn't want to argue this point. Bubbles are all unique in details, even if very similar in structure.

All I meant to do is respond to your thought that rational investors would push things back into line. They might, but then again, they may well not. Not one out of 10 individual investors can avoid the panic/euphoria teeter-totter. And professional investors have important career reasons to herd together,even if they know it is counterproductive in terms of returns. Better a mediocre herd investor with a job, than a contrarian one without.

I make no general case for dividend investing. I believe in free choice.

Ha

 

[NW-Bound]

It is very hard to go against the herd. If it is difficult for the individual investor, it is 10X harder for the institutional investors or money managers.

In the 2000 tech bubble, I read about some MF managers, the wiser ones, being tormented because if they did not load up on internet stocks and dotcoms, their constituents got all upset that the fund trailed behind its peers and people started redeeming to move to "greener pastures". Some got leery of the bubble and started to sell to raise cash. Their investors called in to yell at them that the money sent in to the MF was to be 100% invested, and that if the investors wanted to hold cash, they would have kept it in their bank account.

As an individual investor, you are free to act according to your belief, and to sacrifice some gains compared to an index in some years to make it up the next year when the market turns. MF managers have to keep up with the herd every month or quarter when their investors look up their fund performance.

 

[ERD50]

....

In this scenario does the overall value of my portfolio matter?

...

I don't know how to comment, it's a rather convoluted way to express it. I tried to decode it and it was taking too much effort for me. It might be easier of things were expressed in multiples of your required income pre-tax. I don't know what to do with a 3.33 multiplier of post tax income requirements.

Bottom line, can you convert your portfolio value (not income streams) into a multiple of your post tax income requirements (minus SS and 1/2 the non-COLA pension)? I'm guessing we will come back to my 'convergence' statement - it won't matter if you look at 'income streams' or WR% regardless of 'income stream'.

...

All I meant to do is respond to your thought that rational investors would push things back into line. They might, but then again, they may well not. Not one out of 10 individual investors can avoid the panic/euphoria teeter-totter. And professional investors have important career reasons to herd together,even if they know it is counterproductive in terms of returns. Better a mediocre herd investor with a job, than a contrarian one without.

I make no general case for dividend investing. I believe in free choice.

Ha

I don't disagree with any of that. But I still think it evens out over the long haul.

Can a non-herd-follower take advantage of the shorter term irrationality? Maybe, maybe not. I recall, and made notes to this effect, that the market was getting crazy during the tech boom of the 90's. But I would have got out around 1997. Eventually, I'd be right. But I just looked, and the div adjusted value never dropped low enough for me to get back in at/below my hypothetical exit point. I think it's a pretty tricky thing for me to do, and maybe trickier for the pros, so what choice do I have?

-ERD50

 

[Danmar]

But still, this is letting the desired income, 3.5% or 3% or 4%, drive the investment strategy. And it seems like generating 4%+ income in particular might really drive a portfolio away from an optimum total return.

Perhaps, but I created the portfolio first (well before I retired) then matched my spending to the dividends. Not the other way around.

 

[modhatter]

Because for those of us who have large baskets of stocks/ETFs, you can't simply take 30 different stock positions at $5,000 each, and sell 3% of each one without commissions taking a substantial chunk out of it. (like my portfolio, which has over 400 positions). Also, while growth and income stocks both fall in down markets, I'd rather know that a basket of companies that are yielding about 3.5% will still be paying me that much despite their stock performance...rather than seeing my portfolio holdings drop 20%, and psychologically having to sell off small positions of each holding. I'd rather have an income stream I know is fairly consistent in-place during up and down markets, and still having the same 100 shares of ABC company that can recover after dropping 20%, rather than having that 100 shares of ABC dropping 20%, having to sell off 7 shares to live off of, and then only have 93 shares left to grow.

I think this is the thinking of most income investors who are in retirement. They don't want to be forced to sell their equities when we have a severe hit or drop. Now the only thing not sound with this approach would be you might be more limited in your selection of stocks, and not buy some that would grow much faster in value. Is this the thinking in not adhering to an income approach?

The only other negative I see is the additional taxes incured, where you will owe taxes on your dividends and then if you re-balance at the end of the year, you will incur additional capital gains tax liability. I don't know if the latter is sufficient to warrant abandoning the income strategy.

But assuming that you were able to generate 3% dividend income from your total portfolio, and you needed 3% income from your portfolio as income to live, there still will be a good chance for additional growth from the portfolio to keep up with inflation if you are re-balancing when needed.

I understand money is money and in up years there is no problem. You still take out what you need, re balance and re-invest the rest in additional stocks. But not being forced to sell stocks when they are severely down (or worse declining or flat for very long period) is the thinking of most income investors. So what is the justification for not being concerned with this? I just can't get it through my thick scull.

 

[NW-Bound]

Income investing by itself is not bad. It's only when people start chasing yields and end up buying dividend stocks that turn out to be risky, for example GM before it went belly up.

My former boss was risk-averse and shied away from any stock. He bought a bunch of high-yielding corporate bonds that went belly up. What he thought was safe was anything but.

 

[Chris M]

I think this is the thinking of most income investors who are in retirement. They don't want to be forced to sell their equities when we have a severe hit or drop. Now the only thing not sound with this approach would be you might be more limited in your selection of stocks, and not buy some that would grow much faster in value. Is this the thinking in not adhering to an income approach?

The only other negative I see is the additional taxes incured, where you will owe taxes on your dividends and then if you re-balance at the end of the year, you will incur additional capital gains tax liability. I don't know if the latter is sufficient to warrant abandoning the income strategy.

But assuming that you were able to generate 3% dividend income from your total portfolio, and you needed 3% income from your portfolio as income to live, there still will be a good chance for additional growth from the portfolio to keep up with inflation if you are re-balancing when needed.

I understand money is money and in up years there is no problem. You still take out what you need, re balance and re-invest the rest in additional stocks. But not being forced to sell stocks when they are severely down (or worse declining or flat for very long period) is the thinking of most income investors. So what is the justification for not being concerned with this? I just can't get it through my thick scull.

I think the justification for not being concerned is just what you said--"money is money", and similarly a loss is a loss, whether you realize it or leave it unrealized. If you start out with a $1 million portfolio, the portfolio pays $30,000 in dividends but loses $200,000 in price, you now have $830,000. You can sell $30,000 in shares to meet your expenses, and then re-invest the dividends, or you can spend the dividends--either way you will have $800,000 left after expenses. In fact rather than avoiding realizing your losses, from a tax standpoint it is generally a good idea to realize your losses.

Just remember the dividends have to come from somewhere. A company that chooses to pay out $1 billion in dividends rather than re-invest it will have $1 billion less in assets. It stands to reason that sooner or later the stock price will reflect this. So when you are reaching for yield you are making a choice to take your gains in the form of dividends rather than capital gains. But $1 in capital gains is worth the same as $1 in dividends (leaving the tax issues aside).

Of course, you may have some reason to believe high dividend paying stocks will actually out-perform the market as a whole. There may in fact be good reason to believe this, but in this case you would be choosing high-dividend stocks not for the income, but for the higher total returns you expect.

Chris

 

[clifp]

I don't disagree with any of that. But I still think it evens out over the long haul.

Can a non-herd-follower take advantage of the shorter term irrationality? Maybe, maybe not. I recall, and made notes to this effect, that the market was getting crazy during the tech boom of the 90's. But I would have got out around 1997. Eventually, I'd be right. But I just looked, and the div adjusted value never dropped low enough for me to get back in at/below my hypothetical exit point. I think it's a pretty tricky thing for me to do, and maybe trickier for the pros, so what choice do I have?

-ERD50

I am not saying that dividend stocks and/or income investing necessarily provide a higher withdrawal especially. Although prior to the last few years run up in dividend stocks, there was some evidence that they provided a better risk adjust return, because of the lower volatility. (Virtually all individual stocks in my portfolio have a Beta <1 and some of the MLP less than .5)

In the long run I don't think there is much financial difference between income investing and total return investing for retirement.

The difference is a psychological one and I'd argue that is quite important both in the 5 years before retirement and and first 5 or so year after.

It is similar to the pay of the mortgage debate. You have shown that you are marginally better off keeping a mortgage in retirement than paying it off. But plenty off people want to have the comfort of not having a mortgage. The difference financially is small one and sleeping better at night is better than worrying about the mortgage payment. Even if you and I may think money fungible why sweat it.

Imagine two 60 year old investor Total Return Tom and Income Irv pulled the plug this year and retired
.
After carefully reviewing the literature, evaluating the CAPE ratio and reading the ER board, Tom decide that he was going to withdraw 3.5% of his 75/25 portfolio (with most of the fixed income in a Pen Fed CD ladder) each year. Irv constructs a 75/25 portfolio that yields 3.5% (At the beginning of the 2013 the M* Dividend Builder portfolio was 3.54%)

At the end of 2013 both Tom and Irv portfolio are worth $1,250,000. Irv realized that he received $2,700 worth of dividend increases last year. So his 2014 spending will be $37,700. He sleeps well at night knowing that he isn't touching the principal and his dividend and interest income is more than keeping up with inflation.

Tom struggles with how much to take next year. Inflation is only running about 1.4% this year so adjusting for inflation his 2014 withdrawal should be $35,500. Tom realizes that if he retired at the end of 2013 a 3.5% withdrawal would $43,750. On the other hand Tom was a tad nervous with a 3.5% at Dec 2012 stock market levels at Dec 2013 he is really worried, that he is overspending.

So ERD how much would you recommend Tom spend in 2014?
To me the big benefit of dividend and income investing and tying my spending to income rather than portfolio value, is most years it eliminates the question.

 

[samclem]

To me the big benefit of dividend and income investing and tying my spending to income rather than portfolio value it most years eliminates the question.

If the forced discipline of having to live off dividends works for an investor (e.g. lets them hold an appropriate allocation of equities without selling at a low, etc) , then maybe it is worth the many disadvantages (needing to save more or live on less, probably being concentrated in a few sectors where the higher div stocks are found, etc). Such an investor should consider taking the next logical step just to be sure: don't check the portfolio value. Ever. It might go lower, and there's no point in knowing about that, the only important thing is the number of shares and the dividend per share.

 

[clifp]

If the forced discipline of having to live off dividends works for an investor (e.g. lets them hold an appropriate allocation of equities without selling at a low, etc) , then maybe it is worth the many disadvantages (needing to save more or live on less, probably being concentrated in a few sectors where the higher div stocks are found, etc). Such an investor should consider taking the next logical step just to be sure: don't check the portfolio value. Ever. It might go lower, and there's no point in knowing about that, the only important thing is the number of shares and the dividend per share.

Well during the 2008/9 crisis, the only time I got really nervous was when dividends were cut. In general by looking at the yields and expected dividend growth rates, my reaction during the crisis was buy, buy, buy.

 

[imoldernu]

A humble reminder that retirement doesn't have to be all portfolios, withdrawal rates, stocks and bonds, or the stock market.
Only haf of all americans are invested in the markets.
Some of us plan to live from our savings, and not always earned from market investments.
Historical charts and predictions and market ups and downs were not always the only creators of security. Savings accounts, US Savings Bonds, Housing appreciation, profit sharing and buying and selling of land and properties have been the source of nest eggs for many retirees.

In some cases a generational difference.

 

[haha]

If the forced discipline of having to live off dividends works for an investor (e.g. lets them hold an appropriate allocation of equities without selling at a low, etc) , then maybe it is worth the many disadvantages (needing to save more or live on less, probably being concentrated in a few sectors where the higher div stocks are found, etc).

I would not concede that there are many disadvantages to income investing, at least there are no more than there are to any other style of investing. Everything has pluses and minuses, and the balance changes from time to time.

In particular I disagree that dividend investing causes you to concentrate in certain sectors. This may happen to under-capitalized or unsophisticated investors, but it is the investor, not the method which is responsible. As with anything, there must be an adequate plan, and a quality execution. Each must be reasonable.

Ha

 

[ERD50]

I'm going to take two phrases out of order:

...

Tom struggles with how much to take next year. Inflation is only running about 1.4% this year so adjusting for inflation his 2014 withdrawal should be $35,500. Tom realizes that if he retired at the end of 2013 a 3.5% withdrawal would $43,750. On the other hand Tom was a tad nervous with a 3.5% at Dec 2012 stock market levels at Dec 2013 he is really worried, that he is overspending.

So ERD how much would you recommend Tom spend in 2014?
To me the big benefit of dividend and income investing and tying my spending to income rather than portfolio value, is most years it eliminates the question.

...In the long run I don't think there is much financial difference between income investing and total return investing for retirement. ...

Well, if there isn't much financial difference over the long haul, then how can there be any justification for taking different amounts?

Dividends are one component of total return. I'm just lost as to how focusing on one component can be more helpful than looking at the entire picture. Maybe it's just my thick skull, but I just can't get over 'a dollar is a dollar'.

As far as the question you wrapped up there - do you increase your 3.5% WR to the new, higher portfolio amount, or stick to the initial 3.5% of $1M (plus inflation) - that's been discussed before, the answer is simple but takes longer to spell out than I have time for right now.

I fail to see how matching your spending to the divs of a group of stocks provides any more of 'answer' than anything else. It's just a number.

It would be interesting if FIRECalc, or some other tool provided a 'spend the divs' options, so we could do some historic comps. Lacking that, I'm reluctant to change horses.

... But not being forced to sell stocks when they are severely down (or worse declining or flat for very long period) is the thinking of most income investors. So what is the justification for not being concerned with this? I just can't get it through my thick scull.

I don't think anyone is 'not concerned' about selling in a down market. But I do think that many over rate the fear surrounding this. First off, if you have a conservative WR, let's say 3% - you are probably getting ~ 2% divs from your portfolio. So in any single year, you may be selling ~ 1% of your portfolio. So if it's down 30%, you have to sell 1.43% instead. It's not a huge amount, it's not like you are liquidating a third of your portfolio when it is down.

-ERD50

 

[audreyh1]

There is nothing about being a total return investor that means you would sell stocks at a low - unless you have a 100% stock portfolio which few do. Rebalancing has you buying stocks when they are low and living off of cash and bonds.

 

[Chuckanut]

There is nothing about being a total return investor that means you would sell stocks at a low - unless you have a 100% stock portfolio which few do. Rebalancing has you buying stocks when they are low and living off of cash and bonds.

+1

Bingo!

 

[photoguy]

For me, the question of income investing vs total return boils down to two things: (1) is the dividend causal? I.e. does the fact that a company pays a dividend result in it being more stable and profitable? Do dividends predict future returns for the company? As far as I can tell the answer is no as dividends don't appear in predictive models (e.g. Fama/French) except as they are correlated to value.

(2) How do you amass a large dividend portfolio (outside of retirement accounts) during the accumulation phase without losing substantial amounts to taxes every year?

 

[Danmar]

My div portfolio averaged about 14% CAGR total return over last 3 years. Not sustainable but still pretty good I think. Some businesses throw off capital that cannot be profitably redeployed in their business. These are the kind of stocks I like. Those growing rapidly in high return businesses usually don't pay divs but may be great investments. Generally, companies that have grown their divs for decades are lower risk lower return. Take your pick but on a risk adjusted basis, I like my strategy. My pension is my FI so no bonds for me. Haven't sold a stock in years. Many ways to get to a secure retirement.
EDIT: I went back to the inception of this portfolio and estimate my total return is between 12 and 13% CAGR since Sept 1997.

 

[NW-Bound]

...
Many ways to get to a secure retirement.

+1, although my stock assortment most likely looks nothing like yours.

We do not debate on whether being an engineer or an accountant or a lawyer is the better way to make a living. Yet, we seem to be convinced that our particular way of investing is the only correct way to do it.

 

[haha]

+1, although my stock assortment most likely looks nothing like yours.

We do not debate on whether being an engineer or an accountant or a lawyer is the better way to make a living. Yet, we seem to be convinced that our particular way of investing is the only correct way to do it.

It is because of insecurity. If someone is secure in his method, he does not need others to agree. In fact, he may often prefer that they disagree.

Say you like women with one blue and one brown eye. Are you happy that you may find a bit less competition for these women, or do you try to convince other men that these are the only women worth having?

Ha