Hi From Waxhaw, N.C. Looking for Advice on Dividend Investments

[lennyandgragg1]

Hey there. I have been reading this newsletter for several years now, but have never really asked any questions nor answered any as I do not consider myself knowledgeable enough.
I am 48 years old and was hoping to retire at 55 if possible. I have investments totaling 1.1 million which consists of 90% stocks and 10% bonds. The stocks are mostly index funds. I chose Vanguard because of their low fees.
I recently have read some things talking about buying stocks that produce dividends to create an income stream in retirement without having to sell off funds. From what I have seen, most dividends are in the range of 2-4%, which wouldn't seem to create a high enough income stream unless I had 3-4 million saved. It also seems that anything offering a higher dividend doesn't historically offer a great return otherwise, so it seems I would sacrifice long-term gains for a dividend, but I could be completely wrong.
I guess I was wondering if at this point it is too late to hope to generate a large dividend income by age 55 or even 60. The reason I started thinking about this is because I didn't want to have to sell off my investments when I retire, but try to leave it to grow and pass onto my children if possible.
To give a little more information, I am able to save between $40-50K a year and was wondering if moving forward it would be wise to only invest in dividend producing investments in order to have a decent income stream when I retire.
Any advice is welcomed and feel free to ask for any additional information. I'm a newbie

 

[SevenUp]

From what I have seen, most dividends are in the range of 2-4%, which wouldn't seem to create a high enough income stream unless I had 3-4 million saved. It also seems that anything offering a higher dividend doesn't historically offer a great return otherwise, so it seems I would sacrifice long-term gains for a dividend....

Give yourself credit for "seeing and seeming" well!

Selling some shares in retirement is very common, and is assumed to occur in the discussion of Safe withdrawal rates.

 

[ImThinkin2019]

Hi Lenny,

Kudos to you for living below your means and planning ahead!

Let me tell you what we are doing. It's not necessarily the best but it lets us sleep at night.

We broke our portfolio into two buckets. On is an equity bucket that mirrors the S&P 500 approx. The other is an income producing bucket.

We plan to live off part of the income from the income bucket and leave the equity bucket for our kids. We also will reinvest a portion of the income back into the income bucket so it grows at the inflation rate. (Probably can't grow at 8% but we hope the inflation rate will come down in the future......)

In the income bucket we have some bonds, some private placement debt, and some income producing equity funds. Right now these are JEPI and DIVO.

Because of the income bucket our portfolio volatility - and growth potential - is less than an S&P index fund. But our income is more or less predictable so we are comforted by this when the market goes down.

It's also possible to create income by selling covered calls and other options. We don't do that but there's lots of info on the Active Investors thread about this. JEPI has people who do this but we pay a .35% expense ratio for them to manage it rather than us.

If you study income producing investments you will find a variety of instruments with higher interest rates than standard dividend mutual funds. Each comes with it's own risk....

Your post and questions are good ones and you will get lots of info from this group.

 

[pb4uski]

... From what I have seen, most dividends are in the range of 2-4%, which wouldn't seem to create a high enough income stream unless I had 3-4 million saved. It also seems that anything offering a higher dividend doesn't historically offer a great return otherwise, so it seems I would sacrifice long-term gains for a dividend...

Give yourself credit for "seeing and seeming" well!

Selling some shares in retirement is very common, and is assumed to occur in the discussion of Safe withdrawal rates.

+1 Welcome lennyandgragg1. You seem to well understand the fallacy of the high dividend stocks... that dividend money has to come from somewhere and when dividends are paid they result in a 1:1 reduction in the share price so the value of your holdings go down so it isn't any different from having sold shares to get that money. Or think of it another way... let's say that in the long run that your stocks return 7% with 5% being price appreciation and 2% dividends and that you have a 4% withdrawal rate... on average your portfolio will still grow by 3% annually...the 7% growth less the 4% withdrawal and that 3% annual growth would occur if the stocks had 7% return with 6% price appreciation and 1% dividends or 7% return with 7% price appreciation and 0% dividends. Now to be clear, there will be years where total return is less than 4% (like 2022) so 4% withdrawals will cause a further decline and years where total return is more than 7% so portfolio growth will be more than 3% after 4% withdrawals.

In fact, for most periods, a broad based portfolio will outperform a dividend focused portfolio... play around comparing a $1 million portfolio with $40,000 annual withdrawals adjusted for inflation between VTSMX (Total Stock) and VDIGX (Dividend Growth) in Portfolio Visualizer... for most 20 year periods VTSMX comes out ahead. So in a nutshell, think total return and don't fret about dividends.

You may also find this paper from Vanguard on the subject interesting. https://investor.vanguard.com/inves...ting-a-superior-approach-for-income-investors

In the current low-yield environment, income-oriented investors may be tempted to search for higher-yielding assets to support their spending requirements. However, according to a recently updated paper by Vanguard Investment Strategy Group (ISG), Total Return Investing: A Smart Response to Shrinking Yields, many investors seeking income would be better served if they adopted a total return strategy that spends through capital returns in addition to portfolio income yield. ...

 

[Midpack]

^^^ Outstanding post!

 

[finnski1]

^^^ Outstanding post!

+1

 

[OldShooter]

... In fact, for most periods, a broad based portfolio will outperform a dividend focused portfolio. ...

@lennyandgragg1, an easy to understand explanation for this is that by selecting for dividends you are selecting for older less dynamic companies and companies who don't feel that they have good internal growth opportunities for investments. Another factor, especially recently, is the trend away from dividends and towards stock buybacks. By selecting for dividends, one eliminates companies who are choosing to return money to shareholders via buybacks. (Lots of debate on that practice, but out of scope for this thread.)

Here's a pretty good video on the subject: Dr. Kenneth French on Dividends: https://famafrench.dimensional.com/videos/homemade-dividends.aspx

 

[lennyandgragg1]

Give yourself credit for "seeing and seeming" well!

Selling some shares in retirement is very common, and is assumed to occur in the discussion of Safe withdrawal rates.

I appreciate it.

 

[lennyandgragg1]

Thanks.

 

[Dash man]

Vanguard has a very good dividend appreciation ETF symbol VIG. In the comparison below with VUG, their growth ETF, you’ll notice year to date and over the past years, VIG didn’t go down as much as VUG, even though over five years VUG did better. VIG invests in companies whose dividends grow each year, for extended periods of time, usually at least 25 years. If you invest for dividends that’s the kind of companies you want. Chasing high dividends can be dangerous. Dividend growing companies will be less volatile than pure growth stocks.

 

[lennyandgragg1]

Thank you.

 

[lennyandgragg1]

Great article. Thanks for sharing.

+1 Welcome lennyandgragg1. You seem to well understand the fallacy of the high dividend stocks... that dividend money has to come from somewhere and when dividends are paid they result in a 1:1 reduction in the share price so the value of your holdings go down so it isn't any different from having sold shares to get that money. Or think of it another way... let's say that in the long run that your stocks return 7% with 5% being price appreciation and 2% dividends and that you have a 4% withdrawal rate... on average your portfolio will still grow by 3% annually...the 7% growth less the 4% withdrawal and that 3% annual growth would occur if the stocks had 7% return with 6% price appreciation and 1% dividends or 7% return with 7% price appreciation and 0% dividends. Now to be clear, there will be years where total return is less than 4% (like 2022) so 4% withdrawals will cause a further decline and years where total return is more than 7% so portfolio growth will be more than 3% after 4% withdrawals.

In fact, for most periods, a broad based portfolio will outperform a dividend focused portfolio... play around comparing a $1 million portfolio with $40,000 annual withdrawals adjusted for inflation between VTSMX (Total Stock) and VDIGX (Dividend Growth) in Portfolio Visualizer... for most 20 year periods VTSMX comes out ahead. So in a nutshell, think total return and don't fret about dividends.

You may also find this paper from Vanguard on the subject interesting. https://investor.vanguard.com/inves...ting-a-superior-approach-for-income-investors

 

[lennyandgragg1]

@Old Shooter....Great interview. It explained things very clearly. Is there an ideal situation where one could get the best of both worlds with dividends capital gains or does the stock price usually go down if one is given a dividend?

@lennyandgragg1, an easy to understand explanation for this is that by selecting for dividends you are selecting for older less dynamic companies and companies who don't feel that they have good internal growth opportunities for investments. Another factor, especially recently, is the trend away from dividends and towards stock buybacks. By selecting for dividends, one eliminates companies who are choosing to return money to shareholders via buybacks. (Lots of debate on that practice, but out of scope for this thread.)

Here's a pretty good video on the subject: Dr. Kenneth French on Dividends: https://famafrench.dimensional.com/videos/homemade-dividends.aspx

 

[target2019]

Hey there. I have been reading this newsletter for several years now, but have never really asked any questions nor answered any as I do not consider myself knowledgeable enough.
I am 48 years old and was hoping to retire at 55 if possible. I have investments totaling 1.1 million which consists of 90% stocks and 10% bonds. The stocks are mostly index funds. I chose Vanguard because of their low fees.
I recently have read some things talking about buying stocks that produce dividends to create an income stream in retirement without having to sell off funds. From what I have seen, most dividends are in the range of 2-4%, which wouldn't seem to create a high enough income stream unless I had 3-4 million saved. It also seems that anything offering a higher dividend doesn't historically offer a great return otherwise, so it seems I would sacrifice long-term gains for a dividend, but I could be completely wrong.
I guess I was wondering if at this point it is too late to hope to generate a large dividend income by age 55 or even 60. The reason I started thinking about this is because I didn't want to have to sell off my investments when I retire, but try to leave it to grow and pass onto my children if possible.
To give a little more information, I am able to save between $40-50K a year and was wondering if moving forward it would be wise to only invest in dividend producing investments in order to have a decent income stream when I retire.
Any advice is welcomed and feel free to ask for any additional information. I'm a newbie

We use the ETF from Schwab with a ticker of SCHD (D for dividends) for automatic distribution of dividends each quarter. So a portion of our portfolio is invested that way, rather than buying individual company stocks. However, when you mention growth and passing some to your children, this suggests SCHG (Growth).

That explains the two main components of the broad U.S. stock market (SCHB). In order to make a reasonable judgment, it's most important to understand these components and what happens over time with risk levels.

 

[OldShooter]

@Old Shooter....Great interview. It explained things very clearly. Is there an ideal situation where one could get the best of both worlds with dividends capital gains or does the stock price usually go down if one is given a dividend?

Sadly, there is no free lunch out there, though we've all hoped to find one.

From a logical POV, consider a reductio ad absurdum example: A company that had no business and whose only asset was $1K in cash, which had issued only one share of stock, and the stock price was $1K. OK? Now consider what happens to the stock price after it distributes that $1K to its shareholder. It has to go to zero because there is no more value in the company. The shareholder is fine; he has the same portfolio value as before. But no speculator is likely bid the stock price above zero.

Another way to analyze the hypothesis is to observe that if your idea worked, it would be the equivalent of a free lunch. Free lunches have very short lives in the market. As soon as they are noticed they are arbitraged away. With well over 10,000 funds and institutions watching maybe 6,000 US stocks, any free lunches get noticed very quickly.

That said, beginning the day after a dividend is paid, the employees of any company will still be working away to add value, so one can expect that the stock price will rise appropriately. But that dividend money is gone from the company forever; simple arithmetic tells you that the value of the company must have been reduced accordingly.

None of this says that a dividend strategy is a bad one for any particular individual. Dr. French's idea of it being a forced spending curb might be just the right thing for some. But a dividend strategy is demonstrably not financially optimum for a long term investor. Stock prices are "noisy" in a statistical sense, so the day-after price may not be exactly reduced by the dividend, but any variance will be the result of non-dividend factors.

 

[lennyandgragg1]

Sadly, there is no free lunch out there, though we've all hoped to find one.

From a logical POV, consider a reductio ad absurdum example: A company that had no business and whose only asset was $1K in cash, which had issued only one share of stock, and the stock price was $1K. OK? Now consider what happens to the stock price after it distributes that $1K to its shareholder. It has to go to zero because there is no more value in the company. The shareholder is fine; he has the same portfolio value as before. But no speculator is likely bid the stock price above zero.

Another way to analyze the hypothesis is to observe that if your idea worked, it would be the equivalent of a free lunch. Free lunches have very short lives in the market. As soon as they are noticed they are arbitraged away. With well over 10,000 funds and institutions watching maybe 6,000 US stocks, any free lunches get noticed very quickly.

That said, beginning the day after a dividend is paid, the employees of any company will still be working away to add value, so one can expect that the stock price will rise appropriately. But that dividend money is gone from the company forever; simple arithmetic tells you that the value of the company must have been reduced accordingly.

None of this says that a dividend strategy is a bad one for any particular individual. Dr. French's idea of it being a forced spending curb might be just the right thing for some. But a dividend strategy is demonstrably not financially optimum for a long term investor. Stock prices are "noisy" in a statistical sense, so the day-after price may not be exactly reduced by the dividend, but any variance will be the result of non-dividend factors.

@Old Shooter. Thanks for the detailed explanation. I guess I wanted to make sure I wasn’t missing something before it was too late in my working career. I agree that there is no free lunch!

 

[yhoomajor]

Moderation and Balance is key to most things in life. So is with Dividend and Growth.

SCHD is the sweet spot.

 

[yhoomajor]

Also, I see lot of naive assumptions on this forum about dividend vs non-dividend paying companies.

Lately, more and more Tech companies are included in heavier index (S&P500, Dow 30 and so on). Many (not all) of these companies that are newish, keep paying their employees and C-Suite executives high salaries (cash) as well as RSUs - aka newly printed shares. i.e. share dilution. So big chunk of that earning is funneled to executives who make hundreds of millions per year. They can afford to spend like drunk sailors, after all they don't have to budget or plan for dividends. It works while they are in hyper growth mode (buying revenues - NFLX, PYPL, SQ, Uber, TWTR, SNAP, Lyft, FB, RIVN, PLTR, SNOW, WDAY and so on). Eventually they hit the ceiling on growth front and then stock meets the reality.

Dividends bring discipline to companies's expense structure and plans. There are two kind of dividend paying companies:
- ones that have shrinking revenues (ex: tobacco companies, IBM)
- ones that are growing revenues

You want to stick with latter. Or just buy SCHD for income-focused portion of your portfolio.

 

[OldShooter]

@Old Shooter. Thanks for the detailed explanation. I guess I wanted to make sure I wasn’t missing something before it was too late in my working career. I agree that there is no free lunch!

I think we all started our serious investing careers looking for those free lunches. In my case I tried to use Fourier analysis of historical price series to predict prices. Failed, of course.

Here is what I now tell my adult-ed investing classes: "Investing is boring. If you're not bored, you're not doing it right."