4% rule.

[Running_Man]

In 1994 the SPY ETF paid a 2.66% dividend. If you invested a $1,000,000 and only spent the dividends you would have had $26,600 to spend in the first year, about $48,000 adjusted to today for inflation.

Without ever selling a share of the SPY ETF today you would have $8,150,530 at 12/31/2020. An inflation adjusted Portfolio would have been $1,787,300. Your dividend income would be $199,240 in 2020 a growth rate of eight percent per annum.

In 2009 you would have had your income cut (17%) as well as in 2001(5%), but on average dividends went up 8 percent per year while inflation was 2.17% per year, so the actual amount to spend was an overwhelming abundance to where you an 11% withdrawal rate on an inflation adjusted portfolio.

The obvious advantage of dividend only spending is the relative safety of the dividend level and the amount to cut back versus the drawdowns that occurred in 2001 and 2008, now the FED has made restoring the stock market one of it's primary goals, so living on spending of the portfolio has never hurt much and a market that is up.

But in general if anyone has not done well in the past 25 years there really is no excuse, the market has been extremely generous for a very long time.

 

[Running_Man]

Year Dividends Rate Cumulative Dividends ETF VALUE Div Reinvest
1994 26.60 2.66% 26.60 977.42 1,004.02
1995 28.41 2.83% 55.01 1,321.62 1,386.00
1996 30.77 2.22% 85.78 1,589.50 1,697.70
1997 31.92 1.88% 117.70 2,091.74 2,266.05
1998 33.31 1.47% 151.01 2,661.06 2,916.12
1999 34.41 1.18% 185.42 3,172.20 3,510.66
2000 36.16 1.03% 221.58 2,830.87 3,169.07
2001 34.54 1.09% 256.12 2,467.32 2,796.64
2002 36.92 1.32% 293.04 1,902.11 2,192.90
2003 40.79 1.86% 333.83 2,402.67 2,810.77
2004 55.93 1.99% 389.76 2,612.03 3,111.62
2005 55.70 1.79% 445.46 2,691.35 3,261.81
2006 64.58 1.98% 510.04 3,064.56 3,778.72
2007 72.55 1.92% 582.59 3,163.11 3,972.78
2008 74.69 1.88% 657.28 1,939.39 2,510.51
2009 61.26 2.44% 718.54 2,403.38 3,172.40
2010 65.03 2.05% 783.57 2,715.99 3,650.07
2011 75.19 2.06% 858.76 2,711.32 3,718.98
2012 92.60 2.49% 951.37 3,077.38 4,313.69
2013 102.23 2.37% 1,053.60 3,998.65 5,707.30
2014 119.28 2.09% 1,172.88 4,453.39 6,475.64
2015 133.4 2.06% 1,306.28 4,417.41 6,556.73
2016 146.87 2.24% 1,453.15 4,848.61 7,343.62
2017 158.62 2.16% 1,611.78 5,796.04 8,937.20
2018 171.59 1.92% 1,783.37 5,420.64 8,529.95
2019 192.78 2.26% 1,976.15 6,990.56 11,193.16
2020 199.24 1.78% 2,175.38 8,150.53 13,249.72

 

[Koolau]

As has become obvious in your thread here, this topic has a tendency to get people quite steamed up. Once you understand dividends, you can just ignore any lectures you may get.

Heh, heh, no steam here. Folks are free to do what they want. I simply look upon this site as a place where those of us who have "arrived" can share what helped us get here. I know ego CAN become involved. I've been guilty of that in other discussions, but not here (at least, that's my story and I'm sticking to it.)

If it seems like folks are ganging up on Safire, that's unfortunate because I honestly think we're trying to help - not exert our "authority" or profound superiority. I often relay how I've made every mistake in the books (can you spell abusive tax shelters?) EXCEPT I have been a good saver - my only claim to fame. I always say YMMV because, well, YMMV - steam optional!

 

[OldShooter]

... I simply look upon this site as a place where those of us who have "arrived" can share what helped us get here. ...

No problem. & not picking on anyone in particular.

And the truth is that we do get "interesting" discussions here with people who deeply believe that dividends are free money and that stock sales are "principal." It's tempting to bash those beliefs (in the individual's best interests) because they are so wrong and lead to self-defeating behavior.

My point was only to note that the OP was just spending the dividends that they get from broadly diversified funds, so the risk of chasing dividends with bad portfolio consequences is not there. So, her understanding of future possible risks is important but no need to bash her for sins not actually being committed.

 

[ER Eddie]

Look at two options:


1) You have $1,000 worth of shares. They pay a $10 dividend that you take out. You still have $1,000 worth of shares and $10 in your pocket.


2) You have $1,000 worth of shares. They pay a $10 dividend that you reinvest, so you now have $1,010 worth of shares. You sell $10 worth of shares. You're back to $1,000 worth of shares and $10 in your pocket.


It doesn't matter if you take the $10 from the dividend payment or from the sale of shares. The end result is the same.


Does that make sense? Maybe someone else can explain it differently.

Makes sense.

The only difference I can see is that in the first instance, you're refraining from buying shares, and in the second instance, you're selling shares. That would have slightly different tax consequences -- dividend taxes on the first transaction and capital gains on the second. Iirc, those rates are pretty close, so I'm not sure the difference matters all that much, but I thought I'd point it out as a possible distinction. I believe the rates have differed significantly in the past, and they might again in the future, who knows.

 

[ER Eddie]

At retirement, what if I turned off dividend reinvestment option in my a/cs? That would show me what dividend my portfolio has earned and help me withdraw only that cash?

Right now, I don't check what my funds are earning in dividends. That will only change when we no longer have a paycheck each month.

That's what I do. It's actually quite simple, you just turn off the re-investment option on those funds (you can choose some funds or all, so you can tweak it to the level of income you need). That money then goes into a money-market type account, which I feed into my checking account as needed.

I'd suggest checking what your dividends are spitting out. You can get that information easily from your end-of-year statements. That'll give you a ballpark estimate for how much income you can expect. At least in today's dollars.

Oh, one stat I'll throw your way -- during an average bear market or recession, dividends drop only by about 4%. There are outlier cases where they've dropped more (like 2008-09), but the average drop is only 4%. I can provide a link if you like. That's one of the things I like about relying on dividends, actually. You don't get the stomach-churning drop that you do with equity values during a recession. Yes, money is "fungible," but psychologically, the effect is different, at least for me. I dislike having to sell stock during a downturn, and taking dividends allows me to avoid that (the counter would be that I also lose out on purchasing shares during a downturn).

 

[RunningBum]

Makes sense.

The only difference I can see is that in the first instance, you're refraining from buying shares, and in the second instance, you're selling shares. That would have slightly different tax consequences -- dividend taxes on the first transaction and capital gains on the second. Iirc, those rates are pretty close, so I'm not sure the difference matters all that much, but I thought I'd point it out as a possible distinction. I believe the rates have differed significantly in the past, and they might again in the future, who knows.

You are taxed on dividends whether you reinvest or not.

If you reinvest and then sell, you also have a sale which is a separate taxable event. If you sell the shares you just reinvested, the gain or loss should be very small. But if you're using avg cost basis, there could be a larger gain (or loss).

btw, long term capital gains are taxed exactly like qualified dividends. Not "pretty close", but the same. At least on federal taxes. Likewise, short term capital gains are taxed like unqualified dividends.

 

[Badger]

Yes, but only on the difference between your expenses and (the pension plus social security) - if the pension has a COLA feature.

Taking a dividend payout for living expenses is no different than selling some shares for living expenses.

Please explain. It seems to me if you sell shares then any dividend payout will decrease because fewer shares would result in fewer dividends. But if instead you just take dividends each year then you have the same number of shares for next years dividend payout.

Yes, it can be more complex but then we start playing "What if?" and guessing/predicting since it can go in either direction.



Cheers!

 

[Time2]

Slightly off topic, but taxes will affect the actual spending you get from your 4%. I suggest having all 3 types of savings, tIRA, Roth IRA and a taxable account. Because we don't know how tax laws will change and where dollar limits will be placed, you need money in all 3 types, so you have flexibility, to adjust with tax law changes.

I almost wish I had kept everything in taxable accounts as I can live under the $80k 0% tax bracket. But, that 'loophole' could change in the future.
My first retired tax year, I paid $0 tax, all LTCGs under $80k, the second year I did $75k in Roth conversions and withdrew enough taxable LTCGs for taxes and spending.
I have some taxable accounts that are 50% LTCGs, so if I withdraw $70k, only $35k is taxable, but I have $70k to spend.

 

[ER Eddie]

You are taxed on dividends whether you reinvest or not.

If you reinvest and then sell, you also have a sale which is a separate taxable event. If you sell the shares you just reinvested, the gain or loss should be very small. But if you're using avg cost basis, there could be a larger gain (or loss).

btw, long term capital gains are taxed exactly like qualified dividends. Not "pretty close", but the same. At least on federal taxes. Likewise, short term capital gains are taxed like unqualified dividends.

Thanks for the clarification. So, if you use the dividends rather than reinvest them, you get taxed once (which happens regardless), but if you reinvest the dividend and then sell it, you get taxed both on the dividend and the cap gains.

Have dividend tax rates always been the same as cap gains rates? Or have they differed in the past?

 

[pb4uski]

If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

 

[ER Eddie]

If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

But not necessarily longer than you wanted to.

 

[pb4uski]

True.

 

[TheWizard]

You are taxed on dividends whether you reinvest or not.

If you reinvest and then sell, you also have a sale which is a separate taxable event. If you sell the shares you just reinvested, the gain or loss should be very small. But if you're using avg cost basis, there could be a larger gain (or loss).

btw, long term capital gains are taxed exactly like qualified dividends. Not "pretty close", but the same. At least on federal taxes. Likewise, short term capital gains are taxed like unqualified dividends.

The OP stated that all of their investments are in tax-deferred or Roth accounts, no taxable account presently.
So taxation of distributions is not presently relevant...

 

[ER Eddie]

The OP stated that all of their investments are in tax-deferred or Roth accounts, no taxable account presently.
So taxation of distributions is not presently relevant...

Ah, I missed that. But it may be relevant when she starts taking dividends out of those funds to cover her retirement expenses. Granted, that's 20 years from now...

 

[TheWizard]

Please explain. It seems to me if you sell shares then any dividend payout will decrease because fewer shares would result in fewer dividends. But if instead you just take dividends each year then you have the same number of shares for next years dividend payout...

That depends entirely on what percentage of shares you sell.
If you sell 1-2% each year you should be good forever.
If you sell 5-6% each year you could start seeing a declining nest egg...

 

[audreyh1]

Thanks for the clarification. So, if you use the dividends rather than reinvest them, you get taxed once (which happens regardless), but if you reinvest the dividend and then sell it, you get taxed both on the dividend and the cap gains.

Have dividend tax rates always been the same as cap gains rates? Or have they differed in the past?

Not always, but for a long time now.

In a taxable account, if you are smart about only selling the shares that were recently reinvested, the capital gain or loss would normally be very small.

Certainly in a tax deferred account there is no taxable difference at all.

 

[CRLLS]

Ah, I missed that. But it may be relevant when she starts taking dividends out of those funds to cover her retirement expenses. Granted, that's 20 years from now...

They are not really relevant in the OP's retirement expenses. Any money taken from her 401k is taxed as regular income, whether from cap gains or stock. The money from cap gains or stock in their Roth is not taxed at all. Taxation is indiscriminate in both cases. It is in after tax investments, which she doesn't have, where there is a difference in the way they two are taxed differently.

 

[CRLLS]

That is only if I spend only the number of shares that my dividend reinvestment could have gotten me. If I spend more shares than what my dividends would have purchased I would soon be spending down the principle. Spending only the dividend forces me to conserve the principle. Am I getting this right?




At retirement, what if I turned off dividend reinvestment option in my a/cs? That would show me what dividend my portfolio has earned and help me withdraw only that cash?

Right now, I don't check what my funds are earning in dividends. That will only change when we no longer have a paycheck each month.

You can do that if you want, It certainly is fairly easy. There are other ways to find what dividends were issued. In my Fidelity monthly report I can see what the dividends are each month. It even gives me an estimated dividend over the upcoming 12 months. If you find that you don't withdraw those dividends, They are "usually" swept into a cash fund where they earn relatively next to nothing. I find that reinvesting dividends is a hands-off approach to buying more equities. YMMV.

I will comment that your posts seem to indicate you may not need the money the dividends to live on but if you do want some money from the account, you just don't want to touch the "principle". In actuality, the number of fund shares that you started with. As has been suggested many times here, there is no financial difference between reinvesting dividends, selling stocks and then withdrawing or just withdrawing dividends. If doing the latter helps you sleep better at night and helps you follow a plan, who are we to try to change your mind? It really is a horse and a horse.

 

[Out-to-Lunch]

If you can live only on dividends then you're probably overfunded, which means you may have worked longer than you needed to.

+1

I made exactly this point early on, but it seems that the OP missed my point.

 

[Out-to-Lunch]

Maybe my question should really be - how can we live off SS (assuming only 60% of the amount estimated to be our payout at retirement) & small pension to preserve the retirement a/cs for our son's trust to inherit 100%. What circumstances would make that doable / possible?

I agree, this is really the right question. The answer has nothing to do with what you do with dividends.

Your thread title was "4% Rule." Historically, this was the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have the pot of money stay above $0 for at least 30 years. This has been often referred to as the "Safe Withdrawal Rate" (SWR).

You really want to ask about the "Perpetual Withdrawal Rate" (PWR). This is the fraction of your initial stash that you can withdraw each year (and adjust for inflation), and have it last indefinitely, i.e., maintain your principal. Historically, this has been about 3.3 to 3.5%.

Again, the SWR (4%) explicitly contemplates depleting your pot of money. The PWR is designed that your pot does not decrease in the long term.

The dividend issue is a red herring. The answer to your question is simple, but not easy: You "just" need to accumulate 30 times your anticipated yearly expenses.


More reading: https://portfoliocharts.com/2016/12/09/perpetual-withdrawal-rates-are-the-runway-to-a-long-retirement/

By definition, safe withdrawal rates plan for failure. They are explicitly defined to cause you to just barely not run out of money under certain historic conditions. In contrast, perpetual withdrawal rates follow the first rule of investing — don’t lose money! These are the withdrawal rates that preserved the original inflation-adjusted principal even at the end of the single worst investing timeframe of a given duration. By weathering the storm and leaving you with the same amount of money you started with, you’re prepared not to quietly pass away with a few dollars remaining but to start all over again.

 

[NW-Bound]

Maybe my question should really be - how can we live off SS (assuming only 60% of the amount estimated to be our payout at retirement) & small pension to preserve the retirement a/cs for our son's trust to inherit 100%. What circumstances would make that doable / possible?

The market vagaries are such that it is impossible to guarantee that you will always have 100% of your investments intact at all times, even if you withdraw 0.

Here's something in recent memory, just 13 years ago. Some people do not remember, but I do.

On 2007/10/09, the S&P was at 1565. A year and a half later, on 2009/03/09, it was at 677. That's down to 43c on the dollar (a loss of 57%). OK, if you reinvested dividend, perhaps you still had 46c on the dollar.

Over time, the market has always climbed back. Sometimes it took a couple of decades, sometimes just a couple of years. That's the nature of the beast.


PS. Is it really as bleak as what I showed above? No, it does not have to be, if you are not 100% in stock.

The link provided by Out-to-lunch above claims that with a 60/40 portfolio, you can draw 3.5% (which may be more than the dividend), and even in the worst case 10-year period, still come out with your stash at the its original value, and on an inflation-adjusted basis at that.

But the above still means that you have to be prepared to see your stash being down during that 10-year period. I am going to check to see how far a 60/40 portfolio was down. Certainly, a lot better than the 43c on the dollar recent case I showed above.

 

[NW-Bound]

...
More reading: https://portfoliocharts.com/2016/12/09/perpetual-withdrawal-rates-are-the-runway-to-a-long-retirement/

...
The link provided by Out-to-lunch above claims that with a 60/40 portfolio, you can draw 3.5% (which may be more than the dividend), and even in the worst case 10-year period, still come out with your stash at the its original value, and on an inflation-adjusted basis at that.

But the above still means that you have to be prepared to see your stash being down during that 10-year period. I am going to check to see how far a 60/40 portfolio was down. Certainly, a lot better than the 43c on the dollar recent case I showed above.

I scanned through the link by Out-to-lunch too fast, and missed this important fact. No, the article did not say that the traditional 60/40 portfolio would recover even in the worst 10-year period. It was the "Golden Butterfly" that the article proposes.

This Golden Butterfly Portfolio is:

20% Total Stock Market
20% Small Cap Value
20% Long Term Bonds
20% Short Term Bonds
20% Gold

Sorry for the mistake.

The article says that the most the above portfolio lost was 11%.

Regarding the 60/40 portfolio, I checked with 2 different calculators using historical data. With a 3.5% WR, one calculator says that the lowest the portfolio got down to in a 10-year period was $414K, and the 2nd calculator says $421K.

Taken at face value, it appears that the "Golden Buttefly" porfolio has lower volatility than the traditional 60/40 portfolio. It lost less in the worst case, but I suspect that in the average case it gained less. There's always a trade off somewhere.

 

[Out-to-Lunch]

Regarding the 60/40 portfolio, I checked with 2 different calculators using historical data. With a 3.5% WR, one calculator says that the lowest the portfolio got down to in a 10-year period was $414K, and the 2nd calculator says $421K.

Yes, I agree with everything you wrote, and thanks for the clarification.

My intent was to have the OP focus on long withdrawal periods, like 50 or 60 years, which is of interest to the OP. I admit that I did not consider not ever being down over short periods; I only was thinking about not going to zero in the long run.

 

[NW-Bound]

Yes, I agree with everything you wrote, and thanks for the clarification.

My intent was to have the OP focus on long withdrawal periods, like 50 or 60 years, which is of interest to the OP. I admit that I did not consider not ever being down over short periods; I only was thinking about not going to zero in the long run.

After a long bull market, people tend to think they have the stomach for market volatility. Pedal to the metal. Then, in a bad market downturn, they gnash their teeth, cry their eyes out, sell low and never get back into the market.

Even on a bright sunshine day, one needs to keep in mind the gloomy days that will surely come. It's so easy for people to forget that.

I am by nature a gloomy guy, and I always look behind my shoulder. Having been through two tough market downturns, I am getting used to seeing big losses. Whether the market goes up big or drops fast, I find it exciting, and constantly ask myself what's the right thing to do.