Living off dividends only.

[WealthyDoc]

The following quote is from the “the Oracle of Manitoba", Randy McDuff.  What do people think about this approach?

“Here’s how I planned my retirement:  I built a portfolio of securities that paid modest dividends. I didn't put more than 2% of my portfolio in any one security. I didn't put more than 10% of my account in any one industry. The companies selected had to pay dividends that were less than 35 percent of their after tax income to qualify.  I kept buying these stocks until the dividend income earned from that account matched my pretax employment income.

Then, I could afford to retire.  I would never want to be in a position where I would have to sell stocks in a bear market.  I could go on a one-year holiday and not have to watch my portfolio.  With enough stocks and periodic dividend increases that exceed inflation (over time) I probably won’t ever run out of income.

So here’s “my” magic number.  If you need to match $120,000 of pretax employment income and you can find a portfolio that will pay you 2 percent dividends, then you’ll need $6 million.  If you can build a portfolio that pays you closer to 3 percent then you’ll need $4 million.  In short, bank on a 2 percent to a 3 percent dividend yield, and figure out what you’ll need to invest to match that income.  Then, you can retire in style!”

[AlexxT]

The S&P 500 and the Total Market Index Funds yield dividend of about 1.89%.  So if you're aiming for a 2% dividend yield, just go with the total market index fund and you'll get the best of both worlds.

That's a great strategy if you can amass a portfolio of 50 times your annual expenditures.  That's my goal, as a matter of fact.  However, most people won't be able to have that much at retirement, so they will need to dip into capital to pay the bills.  Therefore they will need a more complex withdrawal strategy.

As many others have pointed out before, if you have enough money, then it doesn't matter how you invest it.  If you have enough, you can just put it under the mattress.

[PhysicianOnFIRE]

I'm interested in total return. Dividends increase tax drag in my taxable account, so they actually have a deleterious effect on my portfolio.

If you want a consistent payout, why not use Vanguard's Managed Payout Fund? It targets a 4% payout. Now you only need half as much as you did with a 2% dividend.

The fact remains that getting a 2% dividend from a $100 piece of equity knocks the value of your piece of equity down to $98. I'd rather be in control of how much I take out of the investment and when. I don't avoid dividend paying funds, but if I could stay equally diversified and do so, I would. The best way I know how to limit them is with growth funds and stocks that pay no dividend, like Berkshire Hathaway. But I stick with my index funds and live with a small amount of tax drag. There are worse problems to have.

I can understand the psychological benefit of the dividend. "I'm able to live off my dividends without selling any shares" is cool to be able to say, but in reality it's hard to make a distinction between you requesting money from the investment (selling shares) and the investment giving a portion of your investment back (a dividend). The main difference I see is who is in control of the distribution.

[Zaphod]

Agree with POF. All these different methods really just appeal to folks with different personalities. There is zero difference in reality between a dividend and selling a share if the underlying world is the same, it seems different, but only to those who cant wrap their mind around that its all capital and holding the same underlying claim on earnings and profits. For proof, instead of using the SWR, they are just using the dividend yield, you see it comes out to the exact same number and reasoning. Overall, even dividend payers need total return or else there is no way a dividend will keep pace with inflation or have a base of funding, so its just a different proxy for the same idea.

Further, it can only be done if you have a large enough portfolio, in which case anything can be done, holding cash, soybeans anything. Its not realistic as the dividend tax treatment makes an already frictioned style even worse. If you're in a lower overall tax bracket its great, but then again, its highly unlikely you've amassed an amount that allows you to live off dividends only.

Good luck finding companies paying out in a range with a low payout % as the method in the OP describes. After the GFC, all these dividend payers took on massive debt, and retirees and several folks piled into the "dividend investing" style. This has led to insane valuations for things like utilities, consumer staples, etc...look at PG, very high PE, decreasing revenues for years, massive debt, etc...Dividend Aristocrats are in a bubble and eventually it will be painful.

In the long run, it seems companies that pay these huge dividends are basically just giving away money that would otherwise be helping to position them and allow innovation in a world thats getting more competitive, seems like a bad strategy. Look at these oil companies, losing money hand over fist, but paying out massive debt fueled dividends. Makes zero sense but thats what american investors seem to want and its really bad for the companies in what prudent management would really shore up some balance sheets and allow better positioning long term.

[Rando]

I don't think much of McDuff's plan for several reasons, some of which are already noted.  There is nothing magical about stock dividends.  There is no guarantee they will continue at their current rates and the underlying stocks are at market risk.  Amassing a nest egg of 50X yearly expenses will be impossible for the great majority of investors.

Finally, I guess the plan here is live on 2% of your portfolio yearly, never touch the principal, die, and leave a huge inheritance.  While it's nice to leave something to your heirs, it is very likely you can withdraw more than 2% and still do just fine (see FireCalc) having a nice lifestyle without the need to save such a huge amount in the first place.

[AlexxT]

PhysicianOnFIRE wrote:

I’m interested in total return. Dividends increase tax drag in my taxable account, so they actually have a deleterious effect on my portfolio.

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I'm not sure that that's true, if your intention is to withdraw that money and spend it.  It is true for your heirs, who would get a step up in basis upon your death.

If the money is in a 401k or IRA, then you'll be paying income tax rates on both dividends and capital gains when you withdraw the money.

If the money is in a taxable account, when you earn dividends, they are primarily long-term dividends, and so are taxed at the lower capital gains rate.  Even when you're in the accumulation and growth phase, after you pay the tax, that money increases your basis, and so in later years it's withdrawn tax-free.  The only extra tax drag would be on short-term dividends, of which there will be very little in most cases.  So you either pay the tax on the dividends now and reinvest the money, or pay the capital gains rate later when you withdraw the money.  I suppose that just like with a Roth vs IRA decision, you could lean towards dividend vs non-dividend paying stocks depending on what you expect your capital gains rate to be when you plan on withdrawing the money, vs what it is now, but personally I think that the actual difference between the two outcomes is too small to worry about.  I suspect that the extra expense and risk involved is not worth the effort.  Plus, if you happen to already have a (small cap) value tilt, then you have your increased dividends already.

 

[Zaphod]

AlexxT wrote:

PhysicianOnFIRE wrote:

I’m interested in total return. Dividends increase tax drag in my taxable account, so they actually have a deleterious effect on my portfolio.

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I’m not sure that that’s true, if your intention is to withdraw that money and spend it.  It is true for your heirs, who would get a step up in basis upon your death.

If the money is in a 401k or IRA, then you’ll be paying income tax rates on both dividends and capital gains when you withdraw the money.

If the money is in a taxable account, when you earn dividends, they are primarily long-term dividends, and so are taxed at the lower capital gains rate.  Even when you’re in the accumulation and growth phase, after you pay the tax, that money increases your basis, and so in later years it’s withdrawn tax-free.  The only extra tax drag would be on short-term dividends, of which there will be very little in most cases.  So you either pay the tax on the dividends now and reinvest the money, or pay the capital gains rate later when you withdraw the money.  I suppose that just like with a Roth vs IRA decision, you could lean towards dividend vs non-dividend paying stocks depending on what you expect your capital gains rate to be when you plan on withdrawing the money, vs what it is now, but personally I think that the actual difference between the two outcomes is too small to worry about.  I suspect that the extra expense and risk involved is not worth the effort.  Plus, if you happen to already have a (small cap) value tilt, then you have your increased dividends already.

 

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It depends on the dividend rate, but its certainly real and you will be taxed on it depending on your marginal rate. This isnt as big a deal if you switch to this plan when retired, but if doing it during the accumulation phase with a profession salary... Over long periods of time/compounding the effect of taxes on dividends for a high earner can be quite significant, reduces your reinvestment. Remember there is tax drag for the company and then for you with dividends. If their is drag it has an effect on share price, etc...as well.

[Centaura]

With 2016 starting with a bang for commodities and some stocks, the year seems to get only better with time for stock market.Getting some inspiration from a successful billionaire investor can be a good start, but ultimately, finding the best dividend stocks to invest in is up to you and, if applicable, your broker. With the likes of George Soros and Carl Icahn making loads of money form dividend stock we can look at the top 5 dividend stocks which can create a buzz in the market and will help in creating a greater ROI for the investors.The surprise being the inclusion of Wells Fargo & Company and the Coca Cola Company, and to add to this there is a surprise entry at the top position "IBM".

Soure: Dividend Paying Stocks

[Centaura]

With 2016 starting with a bang for commodities and some stocks, the year seems to get only better with time for stock market.Getting some inspiration from a successful billionaire investor can be a good start, but ultimately, finding the best dividend stocks to invest in is up to you and, if applicable, your broker. With the likes of George Soros and Carl Icahn making loads of money form dividend stock we can look at the top 5 dividend stocks which can create a buzz in the market and will help in creating a greater ROI for the investors.The surprise being the inclusion of Wells Fargo & Company and the Coca Cola Company, and to add to this there is a surprise entry at the top position "IBM".

Soure: [url url=http://www.profitconfidential.com/tag/dividend-paying-stocks/ ] Dividend Paying Stocks [\url]

[WealthyDoc]

I'm thinking more about this and it may not be a bad strategy actually.  It seems simplistic and not sophisticated but it may not be.  I recently talked to a sophisticated FI investor who lives off dividends.  He had some good points.  He feels he owns a tree that bears fruit.  He plucks some of the fruit but the tree still is fine.  If you use index funds and the "4% rule" you have to pluck some of the branches (by selling some of the underlying asset.)  Things may work out fine and the tree grows new branches and fruit or there is some chance that you will keep pruning the tree and are left with less over time.  He has a point I think since with most monte carlo simulations there is a failure rate where you run out of money.  If you take only dividends off it is unlikely you will run out of money or not keep up with inflation.  Also dividends seem to do well even in recessions.  They are unlikely to ever dip less than 50% for example.  One could buy individual stocks and never plan to sell them or an ETF or mutual fund focused on the Dividend Aristocrats that tend to increase dividends over time.  One argument against this I saw above is that a larger portfolio is required.  It wouldn't have to be that large if you invest in higher dividend large cap stocks.  But also high income/high net worth individuals should be able to create a large pool of capital to start with.  Further thoughts anyone?  Am I just being crazy?

[PhysicianOnFIRE]

WealthyDoc wrote:

I’m thinking more about this and it may not be a bad strategy actually.  It seems simplistic and not sophisticated but it may not be.  I recently talked to a sophisticated FI investor who lives off dividends.  He had some good points.  He feels he owns a tree that bears fruit.  He plucks some of the fruit but the tree still is fine.  If you use index funds and the “4% rule” you have to pluck some of the branches (by selling some of the underlying asset.)  Things may work out fine and the tree grows new branches and fruit or there is some chance that you will keep pruning the tree and are left with less over time.  He has a point I think since with most monte carlo simulations there is a failure rate where you run out of money.  If you take only dividends off it is unlikely you will run out of money or not keep up with inflation.  Also dividends seem to do well even in recessions.  They are unlikely to ever dip less than 50% for example.  One could buy individual stocks and never plan to sell them or an ETF or mutual fund focused on the Dividend Aristocrats that tend to increase dividends over time.  One argument against this I saw above is that a larger portfolio is required.  It wouldn’t have to be that large if you invest in higher dividend large cap stocks.  But also high income/high net worth individuals should be able to create a large pool of capital to start with.  Further thoughts anyone?  Am I just being crazy?

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I can see how living off dividends only has appeal psychologically. You don't have to be a sophisticated investor for this to happen to you. You could own nothing but VTSAX (or any fund under the sun with a 2% dividend) and have annual spending of 2% or less of your net worth. Simple.

Also, the tree analogy doesn't work for me. Thinking of dividends as "fruit only" and stock value as the tree and its branches gives you a false image of creating damage when you sell some of an appreciated fund's value.

I prefer to look at the portfolio not as a tree, but as a big wheel of cheese. Dividends are the equivalent of a stranger cutting off a hunk and handing it to you whether you're hungry or not, irregardless of the tax consequences. If you rely on total return, you only cut off a hunk when you want some cheese and are comfortable with the tax implications.

This is a post I'll be writing sooner or later. The "wheel of cheese" concept just occurred to me, but I like it.

 

 

[Zaphod]

WealthyDoc wrote:

I’m thinking more about this and it may not be a bad strategy actually.  It seems simplistic and not sophisticated but it may not be.  I recently talked to a sophisticated FI investor who lives off dividends.  He had some good points.  He feels he owns a tree that bears fruit.  He plucks some of the fruit but the tree still is fine.  If you use index funds and the “4% rule” you have to pluck some of the branches (by selling some of the underlying asset.)  Things may work out fine and the tree grows new branches and fruit or there is some chance that you will keep pruning the tree and are left with less over time.  He has a point I think since with most monte carlo simulations there is a failure rate where you run out of money.  If you take only dividends off it is unlikely you will run out of money or not keep up with inflation.  Also dividends seem to do well even in recessions.  They are unlikely to ever dip less than 50% for example.  One could buy individual stocks and never plan to sell them or an ETF or mutual fund focused on the Dividend Aristocrats that tend to increase dividends over time.  One argument against this I saw above is that a larger portfolio is required.  It wouldn’t have to be that large if you invest in higher dividend large cap stocks.  But also high income/high net worth individuals should be able to create a large pool of capital to start with.  Further thoughts anyone?  Am I just being crazy?

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There is zero difference between selling a portion of your portfolio or a stock without a dividend and getting a dividend, except a dividend actually has a tax drag, is given whether you want it or not, and takes capital from the company permanently. So I guess I actually prefer a reasonable or no dividend company as they are probably more able to withstand economic surprises. I understand that people all over the internet make zillions of blog posts and psychologically it is appealing. Honestly its so appealing that dividend aristocrats and high yield companies have been bid up to levels that make no sense and will ultimately suffer return wise over the long haul. Sure, you may have your dividends...but even those are likely to be cut or not rise as fast as they recently have (mathematically impossible with stagnant and decreasing revenues). Youre still taking money that could be used by the company for growth or increased profits (eps, etc..) that would be reflected in the value of the company. Again, the analogy is just a simple tool that reflects the personality of the buyer of this idea, and is in no way representative of reality.

In the end the only thing that matters is total return. If I have more total return I have more money, security, etc....no matter how you categorize it, and I can spend more and have less chance of issues than someone with less. Obviously, with a large enough nest egg any strategy works, even just cash in a mattress. So yes, you're being a little crazy and ignoring the math and fungible aspect of money, not too mention the tax drag of dividends on the company and yourself. You're effectively creating your own dividend (with less cost to everyone), and there have been lots of posts by people showing how it still doesnt do anything different than a dividend and your assets dont go to zero. They often use BRK as an example.

This is a strategy that resonates most strongly with people that are looking to retire and dont have enough assets overall to do anything else other than invest in high dividend payers or some like your above and hope they never have to touch principal because it will fail. It is entirely unnecessary for someone with a larger net worth. I think longer term from the GFC on, companies that have insane payout ratios and debt due to their dividends will do worse than similar cap ones that dont. It doesnt give a company like CVX, etc...much wiggle room during downturns to make it (btw, decreasing revenues years before oil tanked) and straddle them with an almost impossible debt load if they dont materially reduce share count with it.

[WealthyDoc]

Lots of great comments from smart people here.  Thanks for talking me off the ledge of dividend madness!

 

[Kamban]

It does not matter whether you think of it as tree with branches and fruit or a cheese wheel. Basically the company is giving a part of the earnings instead of hoarding it or reinvesting it.

Whether you hold a stock on your own or as a part of the mutual fund the dividends from it will be qualified dividends taxed at the favorable capital gains tax rate if you have held the stock for sufficient time as per the IRS rules. In the case of the mutual fund it sends you a 1099-DIV at the end if the year and you pay tax on it. Same with single stock.

The difference between mutual fund and you actually owing the individual stock in your name is that you don't have to pay sale capital gains until you sell the stock and it has appreciated.  In the case of the mutual fund the fund manager sells it and sends you the capital gains for which you have to pay the tax. Sometimes he sells stocks that have losses to balance it out, but then it is in his control and not yours.

As far as dividend stock versus growth stock, in the latter you hope that instead of giving it to you in quarterly chunks you hope the company uses it wisely to grow itself and hence grow the stock price. It works in some cases and sometimes it does not. I have had growth stocks that paid no dividends and either the stock price did not grow or they went up but suddenly crashed and burnt (happened around year 2000) . So if you invested $5000 you lost all the money but if the same thing happened to dividend paying stock you at least got back $1000 before it went up in flames.

There is no one single answer for all investors. I hold individual stocks. Some are dividend plus some growth like P & G and Duke Energy, some started out as growth only but have now become dividend + some growth (Intel) and some are pure growth only with no dividends. When you are younger it is better to place a higher percentage of your investment in growth stocks and as you get older, get more dividend paying stocks. My average dividend payment last year was around 2.5 % for all my stocks combined.

 

 

[Zaphod]

Kamban wrote:

It does not matter whether you think of it as tree with branches and fruit or a cheese wheel. Basically the company is giving a part of the earnings instead of hoarding it or reinvesting it.

Whether you hold a stock on your own or as a part of the mutual fund the dividends from it will be qualified dividends taxed at the favorable capital gains tax rate if you have held the stock for sufficient time as per the IRS rules. In the case of the mutual fund it sends you a 1099-DIV at the end if the year and you pay tax on it. Same with single stock.

The difference between mutual fund and you actually owing the individual stock in your name is that you don’t have to pay sale capital gains until you sell the stock and it has appreciated.  In the case of the mutual fund the fund manager sells it and sends you the capital gains for which you have to pay the tax. Sometimes he sells stocks that have losses to balance it out, but then it is in his control and not yours.

As far as dividend stock versus growth stock, in the latter you hope that instead of giving it to you in quarterly chunks you hope the company uses it wisely to grow itself and hence grow the stock price. It works in some cases and sometimes it does not. I have had growth stocks that paid no dividends and either the stock price did not grow or they went up but suddenly crashed and burnt (happened around year 2000) . So if you invested $5000 you lost all the money but if the same thing happened to dividend paying stock you at least got back $1000 before it went up in flames.

There is no one single answer for all investors. I hold individual stocks. Some are dividend plus some growth like P & G and Duke Energy, some started out as growth only but have now become dividend + some growth (Intel) and some are pure growth only with no dividends. When you are younger it is better to place a higher percentage of your investment in growth stocks and as you get older, get more dividend paying stocks. My average dividend payment last year was around 2.5 % for all my stocks combined.

 

 

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I own indexes and they have dividends, different ones vary of course. I get all the divdends/distributions I need from my muni funds.

Wouldnt call PG a growth company, their revenue has been stagnant and then declining since 2008. True of many of these "cant lose" aristocrats that have been bid up to the stratosphere in a reach for yield. The whole reason they have the return history they do is the opposite of how theyre currently priced, which means their future prices have a decreased probability of repeating their historical feat.

ETFs ameliorate a lot of those MF problems as far as taxes go.