How to decide if you can live off investments or need to draw them down

[target2019]

Thank you for the replies.
I have ran my figures through Firecalc as well as a paid and free FPs. They all said we should be go to go.
I might have muddled my question a bit in my rambling.
I am curious about how people decide if they have enough resources to live off of their investments and thus keeping the principal or use a spend down strategy and use up their investments, hopefully on their last day.
We don’t have any heirs, so 1 way doesn’t necessarily have to win out, but there will be a difference in the way we structure our accounts and the investments in them.

When we took over management of in-laws finances, I made a chart that captured all of their income sources and expenses. This is a cleaner, generalized version.

Your tax questions are more complicated, but you can see that if you estimate tax impact, then it just becomes another output.

So, add up the income numbers (dividends), and compare to the total of red numbers. That shows you whether you can fund the expenses with just dividends and interest thrown off by the investments.

This can be done in a spreadsheet, too.

 

[mathjak107]

after the great depression investors were very leary .

so a company that handed them back money was taken as a sign that the company was so strong financially that they would proclaim , look at me , we have money we don’t even need .

so dividend paying companies were held in high regard .

but over time that became just false thinking …companies paid dividends right in to the graveyard for fear of getting beaten up ..

generating income is only about total return or interest

whether that income is the company handing you the dollars back and subtracting it off your balance , or it comes from appreciation or a mix of both doesn’t matter .

except for taxes it is going to end up the same

 

[FIREd]

I am rather cash-flow poor. I have a commercial real estate investment that pays me rental income on a quarterly basis and a couple of savings accounts that pay me interests on an annual basis. The rest of my money is locked in investment accounts that generate no taxable income whatsoever as long as I don't withdraw any fund (I'm in Europe, things are a bit different over here). When I need money to supplement my rental income, I withdraw from those accounts. Part of the withdrawal is non-taxable (return of capital) and part of it is taxable (earnings). In general, I try to keep my rental income plus any withdrawal from my investment accounts under 3% of assets (WR).

 

[mathjak107]

we used to be very real estate heavy actually owning a decent size real estate business consisting of 9 coop apartments in the prestigious 200 central park south building in manhattan .

the building had converted from rental to coop in the 1980’s so those tenants who didn’t buy stayed on as rent stabilized tenants .

so we bought a package with break even rents , for cents on the dollar .

then we offered the tenants 100k to move so we could sell at market price .

eventually all apartments went .


plus we had a 10% stake in the lease rights in that building which held commercial businesses.

we were partners in the lease rights with real estate mogul bernard spitzer .

those lease rights alone were sold in 2015 for 1.8 million dollars to the real estate developers ashkenazy group .

but last thing we wanted to be in once we retired was real estate .

so everything was sold and now we have only nice liquid investable assets that can be bought sold or swapped with a mouse click

 

[thefist]

The only sometimes advantage about dividend paying companies is that at least some of the money is not available for the CEO and board to squander on bad purchases or stock grants.

But Seadrill paid a very nice dividend, until it drilled the shareholders.

If there is concern about a CEO squandering retained earnings, why own the stock in the first place?

 

[OldShooter]

There is nothing easier than to look at mergers, acquisitions, and new ventures in the rear view mirror and identify failures. I leave that to HBS case studies because the reasons are usually quite complicated.

One strength I see in the Amazons and Googles is their willingness to try things and to pull the plug on ideas that don't work out. Back in olden times, Amazon took a lot of flack for investing a large chunk of its profits in new initiatives, some of which were eventually abandoned. But many did succeed and that "let's try it" attitude is what built the company we see now. Even a turtle can't make progress without sticking his neck out.

Not that there aren't idiots out there, but the Monday morning quarterbacks who hold the stocks aren't showing genius credentials themselves (per @thefist's question above).

 

[mathjak107]

If there is concern about a CEO squandering retained earnings, why own the stock in the first place?

exactly.

actually the whole concept of giving a company money and wanting them to invest it and grow it and then they give it back to you and say sorry we can’t grow this , is crazy

 

[marko]

why does a company have to hand me back my money when i can take it myself from a portfolio, or stock even if non div payers.

if i believe in a company enough to invest in it , i want them to compound my invested dollars . i dont need them to hand me my dollars back

I was a senior exec at a company where paying dividends was not common in the industry. But we were extremely profitable with zero debt and had more than enough cash for any R&D, acquisitions or other ventures. We had our problems but cash wasn't one of them!

Our belief was that the 'owners' (share holders) deserved a share in our profits. In addition to our quarterly dividends we'd even have extra-ordinary one-time distributions of as much as 10X from time to time. We'd get letters from average folks thanking us.

 

[OldShooter]

Other than dividends, how should a company return capital?
I like dividends better than stock buy backs. Dividends are steady or if not draw a good amount of attention. Buybacks are timed randomly. Are they buying back when you would be buying more? Also, I’m still not convinced that buybacks arent used for corporate shenanigans timing them to cover issues or at a boards/C-suite convenience.

Nothing wrong with liking dividends over buybacks. There are degrees of problems with both, most specifically the tax aspects of dividends, both timing and rates. In general I think the academic experts would strongly prefer the buybacks.

exactly. actually the whole concept of giving a company money and wanting them to invest it and grow it and then they give it back to you and say sorry we can’t grow this , is crazy

I think it goes with the territory. Utilities, for example, may have limited investment options where tech companies may not. Should not, even. Buffett has been struggling with this, finally somewhat resolving it with share buybacks that at one point IIRC he didn't like.

 

[mathjak107]

I was a senior exec at a company where paying dividends was not common in the industry. But we were extremely profitable with zero debt and had more than enough cash for any R&D, acquisitions or other ventures. We had our problems but cash wasn't one of them!

Our belief was that the 'owners' (share holders) deserved a share in our profits. In addition to our quarterly dividends we'd even have extra-ordinary one-time distributions of as much as 10X from time to time. We'd get letters from average folks thanking us.

maybe it was profits in your case but dividends have nothing to do with profits .

dividends are paid even when companies lose money for years , or they are paid right in to the blue chip graveyard.

there are merely an amount of money the board votes on to pull out of the company cash register and send out to investors .

the exchange computers then make the deduction off the share price for the same amount withdrawn.

it can come not only from profit if any , but the sale of assets , law suits they won , etc .

i even had a reit that when profits couldn’t sustain the pay out , they used both the money ear marked for buying property and worse , loans

 

[pb4uski]

maybe it was profits in your case but dividends have nothing to do with profits...

Technically incorrect. Dividends are paid out of retained earnings, so in order to pay dividends there have to have been some past earnings that were not paid out to shareholders.

You can't pay dividends if it would result in a retained deficit or if you have a retained deficit.

Those REITs that make distribtions in excess of profits are a return of capital.

 

[mathjak107]

when a company loses money year after year and losing money it’s being paid out of what ever cash the company has .

it could be an asset sale they lost money on that they sold off .

but in any case the dividend is just coming out of the cash register wherever that money came from .

in the case of our reit it was money we gave them to buy properties.

they ended up using some of it and borrowed money to keep paying.

it was interesting because back when i had the reit a decade or more ago the first tip off something was up was they paid a 6% dividend yet the 1099 reflected no where near that.

that was because as you said it was a return of capital making that up

 

[pb4uski]

You can try to rationalize it all you want but you are still wrong... dividends can only be paid from retained earnings... so by definition dividends are the payment of unremitted past profits.

You might receive some other distribution from a company, but it isn't a dividend. Just the way it works.

 

[mathjak107]

well the money had to come from somewhere so obviously there had to be profits at one point …

but a company can be circling the drain and still pay from that company cash register.

so the point is it doesn’t mean they are still profitable

 

[pb4uski]

well the money had to come from somewhere so obviously there had to be profits at one point …

About time you got it.

To be clear, a company can make distributions to shareholders without any retained earnigns if they have the case to do so, it is just that those distributions would NOT be dividends.

 

[LateToFIRE]

well the money had to come from somewhere so obviously there had to be profits at one point …

but a company can be circling the drain and still pay from that company cash register.

so the point is it doesn’t mean they are still profitable

About time you got it.

To be clear, a company can make distributions to shareholders without any retained earnigns if they have the case to do so, it is just that those distributions would NOT be dividends.

So, when a private equity sponsor uses debt to finance a special "dividend" to shareholders (i.e. back to the sponsor), what is that called. It's not necessrily from retained earnings - it's from borrowing. In my experience it's called a "levered dividend" or a "dividend recap" but pb4uski, sounds like you'd disagree.

 

[pb4uski]

Yes, it is not a dividend. Dividends can only be paid from retained earnings.

I guess there are a couple exceptions, and the second exception below may be what you are referring to and those exceptions are rare, but those exceptions are not what mathjak and I were referring to.

What they refer to as a liquidation dividend below I have heard referred to as a terminal distribution.

Can a dividend be paid in excess of profits?

Generally, no, a company cannot pay a dividend in excess of its profits. However, there are some nuances to consider:

1. Profits vs. Retained Earnings:

While not directly linked to current profits, dividends are typically paid from retained earnings. These represent accumulated profits after accounting for dividends and other distributions in past years. So, a company might pay a dividend exceeding its current year's profits, but not exceeding its total retained earnings.

2. Exceptions:

• Dissolution dividend: When a company ceases operations, it can distribute assets (including cash) to shareholders as a final "liquidation dividend," even if there are no retained earnings.
• Debt-funded dividends: Companies can rarely use debt to fund dividends, though this is generally considered risky and unsustainable.

3. Important Points:

• Focus on cash and retained earnings: While earnings per share (EPS) is valuable, the key metrics for understanding dividends are cash and retained earnings.
• Signal to investors: Paying dividends exceeding profits or retained earnings can raise concerns about financial health and sustainability.

Additional notes:

• Regulations: Some countries or industries have specific regulations regarding dividend payments.
• Company policies: Companies often have internal policies outlining dividend payout ratios based on factors like profitability and future investment needs.

If you're interested in a specific company's dividend policies or financial health, it's best to consult their financial statements, investor relations materials, or consult with a financial advisor.

 

[LateToFIRE]

Yes, it is not a dividend. Dividends can only be paid from retained earnings.

I guess there are a couple exceptions, and the second exception below may be what you are referring to and those exceptions are rare, but those exceptions are not what mathjak and I were referring to.

What they refer to as a liquidation dividend below I have heard referred to as a terminal distribution.

Thanks, interesting.

Lol on the part where it says "Debt-funded dividends... considered risky and unsustainable." Yeh, I've seen more than a few of these in my time, and yeh... they can kinda blow up pretty spectacularly. But, basically standard procedure in the private equity world.

At any rate, seems that the market often uses the term "dividend" somewhat more loosely than the technical accounting definition.

 

[pb4uski]

Perhaps, but I'd bet the house that those two exceptions account for less than 0.1% of dividends paid by number or in dollars.