The Mystery of Spending Only Dividends Behavior

[samclem]

I am new to posting on this blog but have developed a system where my bonds , CDs and stocks allow me to live off interest and dividends along with my pension. Is there something wrong with this idea? I realize that CD rates may drop but as longs as i can get 2% returns on CDs and dividends I think I am ok. . . . I don't like risk.

There's nothing wrong with this approach, but there are things to watch/be aware of:
1) If your stocks have been chosen in order to produce high dividends, it is easy to get concentrated in just a few sectors (e.g. financials). This lack of diversification can increase risk (expressed as price volatility) compared to a broader portfolio.
2) A dividend-only approach will leave a lot of assets in the portfolio at the end unless equities are brought to very low levels as you get older.
3) "I don't like risk." What kind of risk are you seeking to avoid? Some people construct portfolios that avoid price volatility, but at the same time increase other risks (especially due to inflation). That's an easy mistake to make.

 

[CRLLS]

Another things which adds simplicity to using dividends and not selling shares is the ability to keep my tax return simple. Every time you sell shares, you trigger another somewhat annoying entry on Form 8949. Furthermore, if I make no redemptions/sales of any shares (in my taxable account), I can avoid Schedule D altogether. A few years ago, before the recent (screwy) tax law change, I made no redemptions and took the standard deduction, enabling me to switch to Form 1040A and end up with a very simple return. With the new tax law, making no redemptions can also save me from filing Schedule 1.

Dividends, whether taken as cash or reinvested, cause the same work on your tax return.

As I stated earlier, my investments are purely IRA's (both tIRA and Roth) at the moment. Selling tIRA shares simply generates a 1099-R. Difficult to get any simpler than that for filing taxes. My situation most certainly will change once RMD's are required as excess will be reinvested in a taxable account. At that time, your comments are valid. In the meantime, life and taxes are simple for me.

 

[misanman]

I sometimes sell shares in my tIRA but that has never resulted in a 1099-R.

 

[scrabbler1]

As I stated earlier, my investments are purely IRA's (both tIRA and Roth) at the moment. Selling tIRA shares simply generates a 1099-R. Difficult to get any simpler than that for filing taxes. My situation most certainly will change once RMD's are required as excess will be reinvested in a taxable account. At that time, your comments are valid. In the meantime, life and taxes are simple for me.

I am not old enough to withdraw from my tIRA. Yes, withdrawals from there are treated as ordinary income, regardless of their source within the tIRA. But for those of us young-uns who are withdrawing only from taxable accounts, taking frequent dividends as cash while keeping all of mutual fund shares intact will greatly simplify our taxes, not generating cap gains or losses.

I do occasional rebalancing moves within my tIRA, selling stock fund shares while buying bond fund shares (or vice versa). None of those moves generate taxable cap gains or losses (or a 1099-R form, misanman).

 

[RunningBum]

But for those of us young-uns who are withdrawing only from taxable accounts, taking frequent dividends as cash while keeping all of mutual fund shares intact will greatly simplify our taxes, not generating cap gains or losses.

I've heard the saying, "Don't let the tax tail wag the dog", meaning don't be overly focused on tax issues and lose sight of the big picture with your investments. This seems to be another version of this, maybe "Don't let the tax forms wag the dog."

Just an observation. I'm sure filling out 1040A would be quicker than doing 1040, but I don't find it takes me very long at all to do 1040.

 

[RobbieB]

Taxes? Just input the stuff into the software and don't sweat it. Easy.

 

[COcheesehead]

Taxes? Just input the stuff into the software and don't sweat it. Easy.

+1 Importing transactions into TurboTax takes like...19 seconds.

 

[RunningBum]

Taxes? Just input the stuff into the software and don't sweat it. Easy.

Yep. You don't even have to input, just import all the 1099 info, and it'll grab any trades along with dividends.

 

[scrabbler1]

I do my own taxes. Just for kicks, I tried Turbo Tax 2 years ago as a check on my work and it gave me garbage, total sci-fi garbage. I'll keep doing my own taxes, and those of my best (snake-bit) friend and my ladyfriend. From my admittedly warped perspective, I have no idea how it actually works correctly for anyone!


As for tail-wag-tax-form-dog, I don't let that dissuade me from making redemptions, even the first one late in the year, to trigger Form 8949 and Schedule D.

 

[RunningBum]

Oh, yeah, I remember that thread.
http://www.early-retirement.org/forums/f28/tax-software-accuracy-90879.html#post2014657
Not going to go down that path again.

 

[gwraigty]

I do my own taxes. Just for kicks, I tried Turbo Tax 2 years ago as a check on my work and it gave me garbage, total sci-fi garbage. I'll keep doing my own taxes, and those of my best (snake-bit) friend and my ladyfriend. From my admittedly warped perspective, I have no idea how it actually works correctly for anyone!


As for tail-wag-tax-form-dog, I don't let that dissuade me from making redemptions, even the first one late in the year, to trigger Form 8949 and Schedule D.

Ditto for having a bad experience with Turbo Tax. They messed up handling my husband's employer contribution to his HSA 2 years in a row. It was a software issue at the time, according to the forums. It seems that every year you can find a discussion topic somewhere on how Turbo Tax isn't handling something properly. I'm a free fillable forms fan myself.

 

[retiredgeek]

In my former country (where my income comes from), you can easily build a consistent dividend portfolio (stocks, reits and tresury bonds) which will give you 5-6% of dividend yield, when you go to the conservative side. If you wanna get more DY and less growth, increase reits, electrical and bank stocks. Then, you might be at a 7-8% DY. In both cases, they would grow faster than inflation (specially bank stocks).

By the other hand, stock prices fluctuates a lot. In no way I would be safe if I dip into principal.

 

[target2019]

Dividend investors is a raging topic on Bogleheads - "The "dividend preference anomaly".

Anyways, have a nice day.

 

[ERD50]

For the "dividend investors" who claim they don't want to touch principal, you should become aware that dividends actually do come out of principal. You are, in effect "touching principal" every time you take a dividend. It's an illusion to think they don't.

The difference being, dividends force principal on you, rather than you deciding when to take principal.

As I showed in another thread (and should be common knowledge), until the company issues the dividend, that dividend value is reflected in the stock price. It is part of principal. This can be most easily seen at the ex-dividend date when there is a large distribution - year end of some mutual funds demonstrate this, but an individual stock does the same. Just a little harder to see with volatility and the usually smaller quarterly dividends.

Ignoring volatility and other factors, a $100 stock that has accumulated $4 in divs, will have risen to $104 before the dividend date. It will then pay out the $4 div, and drop back to $100 on that day. The $4 came out of principal. There really is no other place for it to exist, and the market won't ignore it (even if "dividend investors" choose to).

Dividend investors is a raging topic on Bogleheads - "The "dividend preference anomaly".

Anyways, have a nice day.

Thanks, will read it later.


-ERD50

 

[Chuckanut]

For the "dividend investors" who claim they don't want to touch principal, you should become aware that dividends actually do come out of principal. You are, in effect "touching principal" every time you take a dividend. It's an illusion to think they don't.

The difference being, dividends force principal on you, rather than you deciding when to take principal.

-ERD50

It’s this kind of thinking that keeps you on my list of dangerous radicals who infest this site.

 

[Dash man]

For the "dividend investors" who claim they don't want to touch principal, you should become aware that dividends actually do come out of principal. You are, in effect "touching principal" every time you take a dividend. It's an illusion to think they don't.

The difference being, dividends force principal on you, rather than you deciding when to take principal.

As I showed in another thread (and should be common knowledge), until the company issues the dividend, that dividend value is reflected in the stock price. It is part of principal. This can be most easily seen at the ex-dividend date when there is a large distribution - year end of some mutual funds demonstrate this, but an individual stock does the same. Just a little harder to see with volatility and the usually smaller quarterly dividends.

Ignoring volatility and other factors, a $100 stock that has accumulated $4 in divs, will have risen to $104 before the dividend date. It will then pay out the $4 div, and drop back to $100 on that day. The $4 came out of principal. There really is no other place for it to exist, and the market won't ignore it (even if "dividend investors" choose to).





Thanks, will read it later.


-ERD50

Ultimately, a stock’s value is what another buyer is willing to pay for it, which we all know changes thousands of times each day. If you ask for that $104 stock at $100, because the dividend was just paid, but there are no sellers at that price for any reason, you won’t be buying that stock. You’re just playing a bookkeeping game.

 

[marko]

For the "dividend investors" who claim they don't want to touch principal, you should become aware that dividends actually do come out of principal. You are, in effect "touching principal" every time you take a dividend. It's an illusion to think they don't.

I think most dividend investors understand that but like "when to take SS or paying off the mortgage" and such it is not only a psychological issue but also one of personal taste more than raw math.

My personal reasons are: 1) the dividends are taken out and set aside regularly and automatically. I don't have to think about selling shares at the wrong time (I'd hate to have had to replenish by selling shares in Dec 2008) and

2) back to my old acreage analogy, I'm only selling the corn that I grew, not the land it grew on, which psychologically just feels right for me to have the same amount of shares I started with. Historically those continue to grow in value despite having withdrawn the dividends and most often revert to their pre-dividend value in short order.

 

[ERD50]

Ultimately, a stock’s value is what another buyer is willing to pay for it, which we all know changes thousands of times each day. If you ask for that $104 stock at $100, because the dividend was just paid, but there are no sellers at that price for any reason, you won’t be buying that stock. You’re just playing a bookkeeping game.

That just isn't a factor in the real world, with a liquid stock of the type the "dividend investors" are looking at.

For thinly traded stocks, sure - but that is true if it pays a dividend or not, so it isn't a factor in dive-payers versus non/low-div payers.

Like the seasons, in late fall/early winter, this forum can expect an "OMG" post from someone who just saw their well-known, relatively stable fund drop 10% overnight. And it almost always is a large year-end distribution.

Calling it a book-keeping game doesn't make it any less real. After all, as far as I can tell, almost all my net worth is represented by some bookkeeping entries on a computer somewhere.

-ERD50

 

[ERD50]

I think most dividend investors understand that but like "when to take SS or paying off the mortgage" and such it is not only a psychological issue but also one of personal taste more than raw math.

My personal reasons are: 1) the dividends are taken out and set aside regularly and automatically. I don't have to think about selling shares at the wrong time (I'd hate to have had to replenish by selling shares in Dec 2008) and

2) back to my old acreage analogy, I'm only selling the corn that I grew, not the land it grew on, which psychologically just feels right for me to have the same amount of shares I started with. Historically those continue to grow in value despite having withdrawn the dividends and most often revert to their pre-dividend value in short order.

And of course, there is nothing "wrong" with that, and nothing "wrong" with focusing on div-payers (though I do feel it could be leading to lower diversification, which has a chance of being a problem?).

I just feel people should understand what they are getting into - some seem to assign some sort of 'magic' to dividends, but it's just another way that they are tapping principal. I prefer the flexibility of tapping principal where/when I define, and wish that all my investments retained all dividends, like my BRK.

-ERD50

 

[pb4uski]

Ultimately, a stock’s value is what another buyer is willing to pay for it, which we all know changes thousands of times each day. If you ask for that $104 stock at $100, because the dividend was just paid, but there are no sellers at that price for any reason, you won’t be buying that stock. You’re just playing a bookkeeping game.

But if you're a buyer and willing to pay $104 for the stock on Tuesday, and the company pays $4 dividend after the close on Tuesday, how much would you be willing to pay for that stock Wednesday morning? $104? or something other than $104? Why?

 

[MRG]

But if you're a buyer and willing to pay $104 for the stock on Tuesday, and the company pays $4 dividend after the close on Tuesday, how much would you be willing to pay for that stock Wednesday morning? $104? or something other than $104? Why?

I can tell you what the open price is...

 

[retiredgeek]

Dividends and stock price can fluctuate less dependently. Dividends are related to company profit. Stock prices are defined by market using a lot of variables. So, the “dividends come from principal” argument is essentially insufficient.

 

[OldShooter]

Dividends and stock price can fluctuate less dependently. Dividends are related to company profit. Stock prices are defined by market using a lot of variables. So, the “dividends come from principal” argument is essentially insufficient.

Well, I think it's pretty clear that if you take some water out of a glass, there is less water left in the glass.

In the end, the value of a stock is its future cash flows plus any future price appreciation. If a dividend is paid, future cash flows are reduced.

It is hard to see how reducing the company's cash by the value of that dividend would increase future appreciation, even considering behavioral factors. So the value of what's left after the dividend is paid has to be less.

 

[COcheesehead]

Dividends and stock price can fluctuate less dependently. Dividends are related to company profit. Stock prices are defined by market using a lot of variables. So, the “dividends come from principal” argument is essentially insufficient.

But its true. A dividend is lopped off the end of the stock price. That is why there is an ex dividend date and the value falls. You gain the value back on the pay date and you can choose how to receive it. As cash or reinvested.

 

[Dash man]

That just isn't a factor in the real world, with a liquid stock of the type the "dividend investors" are looking at.



For thinly traded stocks, sure - but that is true if it pays a dividend or not, so it isn't a factor in dive-payers versus non/low-div payers.



Like the seasons, in late fall/early winter, this forum can expect an "OMG" post from someone who just saw their well-known, relatively stable fund drop 10% overnight. And it almost always is a large year-end distribution.



Calling it a book-keeping game doesn't make it any less real. After all, as far as I can tell, almost all my net worth is represented by some bookkeeping entries on a computer somewhere.



-ERD50

Reads like you’re talking funds and I’m talking stocks. They react differently.