Touching The Principal!

[Kerim]

So the holy grail of dividend growth investing is growing your dividend stream to the point that it covers all of your expenses, allowing a comfortable retirement without having to sell stocks or otherwise tap into your principal. Dividend growth in retirement offsets (or beats) inflation, and your standard of living is not compromised as the year roll by.

I love that goal and find it inspiring – I truly hope that I am able to make it to that point. But I am also a realist, and I understand that I and many others may never get there. In my own case, I save and invest diligently, but my monthly expenses are quite high, and unlikely to shrink any time soon. To truly live off the income alone, my dividend growth portfolio would have to get pretty darned large indeed.

But I’ve never really understood the feud between the “never touch the principle” dividend growth people and the “growth is all that matters” people who look forward to living their retirements by drawing down the principal (according to the “4 percent withdrawal” rule or some variation thereon). In all likelihood, many of us will be forced to adopt a hybrid of the two approaches, because if you don’t start early enough or if you simply aren’t able to put away enough every month, then you may never accumulate a pile large enough to live off the dividends alone. As I’ve said elsewhere, if I can generate enough dividend income to cover a large chunk of my expenses, and have to sell of 1 or 2 percent of my portfolio each year to cover the gap, I should still be all right throughout retirement.

But a related thought gets much less attention than I think it deserves in the dividend growth community: If you are willing to touch the principle, you can retire on a smaller nest egg. I think some DG’ers get so focused on living off the income stream that they overlook this fact. This idea has been clear in my head for a long time, but I finally sat down and came up with a very simple illustration:

   

Assuming a 4 percent yield, if you are unwilling to touch the principle, you’ll need a nest egg of $1,250,000 to fund 40 years of retirement at $50,000 per year. If you are willing to burn up the principle, you’ll only need $1,000,000. Of course this is very simplified. It ignores taxes, as well as inflation and dividend growth (though for back-of-the-envelope purposes, I am comfortable assuming that inflation and dividend growth offset each other). While these illustrations show retirement at 60 in both cases, needing less to start could instead mean an earlier retirement. It could take several (or more) years to save that last $250,000.

Of course, your goals must reflect your individual values. If it is important to you to leave huge sums of money to your heirs or charity, then it may be worth it to you to work until you can achieve Scenario A. If you want to retire as early as possible, it may be worth running the numbers on something like Scenario B. And note, by the way, that in some sense the numbers in Scenario B are conservative – if you only live to 95, you’d still be leaving a good chunk of money behind.

Thoughts?

[cannew]

What happen to the DG? Why have you not factored in the growth of the dividends. I posted recently that the stocks I hold generated a growth of just over 6% from the previous year, and many posted much higher growth.

The stocks I hold have consistently provided an increase in the dividends paid and I am currently receiving over $60,000 annually. Even at the lowly 6% increase, the dividends I receive will double in 12 yrs (rule of 72). Take your figures and factor in a 6% increase and see how you end up.

Age Nest Egg 4% Yield & 6% Gth Draw & 5% Inc Balance
60 1,250,000.00 62,500.00 -50,000.00 1,262,500.00
61 1,262,500.00 66,250.00 -52,500.00 1,276,250.00
62 1,276,250.00 70,225.00 -55,125.00 1,291,350.00
63 1,291,350.00 74,438.50 -57,881.25 1,307,907.25
64 1,307,907.25 78,904.81 -60,775.31 1,326,036.75
65 1,326,036.75 83,639.10 -63,814.08 1,345,861.77
66 1,345,861.77 88,657.44 -67,004.78 1,367,514.43
67 1,367,514.43 93,976.89 -70,355.02 1,391,136.30
68 1,391,136.30 99,615.50 -73,872.77 1,416,879.03
69 1,416,879.03 105,592.43 -77,566.41 1,444,905.06
70 1,444,905.06 111,927.98 -81,444.73 1,475,388.31
71 1,475,388.31 118,643.66 -85,516.97 1,508,515.00
72 1,508,515.00 125,762.28 -89,792.82 1,544,484.46
73 1,544,484.46 133,308.02 -94,282.46 1,583,510.02
74 1,583,510.02 141,306.50 -98,996.58 1,625,819.94
75 1,625,819.94 149,784.89 -103,946.41 1,671,658.42
76 1,671,658.42 158,771.98 -109,143.73 1,721,286.67
77 1,721,286.67 168,298.30 -114,600.92 1,774,984.05
78 1,774,984.05 178,396.20 -120,330.96 1,833,049.29
79 1,833,049.29 189,099.97 -126,347.51 1,895,801.75
80 1,895,801.75 200,445.97 -132,664.89 1,963,582.83
81 1,963,582.83 212,472.73 -139,298.13 2,036,757.42
82 2,036,757.42 225,221.09 -146,263.04 2,115,715.47
83 2,115,715.47 238,734.35 -153,576.19 2,200,873.64
84 2,200,873.64 253,058.42 -161,255.00 2,292,677.06
85 2,292,677.06 268,241.92 -169,317.75 2,391,601.23
86 2,391,601.23 284,336.44 -177,783.63 2,498,154.03
87 2,498,154.03 301,396.62 -186,672.82 2,612,877.84
88 2,612,877.84 319,480.42 -196,006.46 2,736,351.80
89 2,736,351.80 338,649.24 -205,806.78 2,869,194.26
90 2,869,194.26 358,968.20 -216,097.12 3,012,065.34
91 3,012,065.34 380,506.29 -226,901.97 3,165,669.66
92 3,165,669.66 403,336.67 -238,247.07 3,330,759.25
93 3,330,759.25 427,536.87 -250,159.43 3,508,136.69
94 3,508,136.69 453,189.08 -262,667.40 3,698,658.37
95 3,698,658.37 480,380.42 -275,800.77 3,903,238.03
96 3,903,238.03 509,203.25 -289,590.81 4,122,850.47
97 4,122,850.47 539,755.44 -304,070.35 4,358,535.57
98 4,358,535.57 572,140.77 -319,273.86 4,611,402.48
99 4,611,402.48 606,469.22 -335,237.56 4,882,634.14
100 4,882,634.14 642,857.37 -351,999.44 5,173,492.07

Of course things don't happen in a straight line and there may be years when the DG is less than 6%, but the may also be years where it higher. But I have had a consistent growth and I expect the growth to continue.

[hendi_alex]

For a pure growth portfolio, selling shares does not equate to drawing down the principal. If growth is greater than the value of liquidation each year, then the growth portfolio could also fully fund retirement without drawing down the principal from its initial value at the start of retirement. Personally, I don't really see any difference. Dividends paid out are essentially 'return of capital'. Either way, spending dividends or selling shares moves the portfolio from the accumulation phase to the distribution phase. To me the real problem with the growth portfolio comes when distributions must be taken during a harshly down market. During those times, IMO a dividend portfolio is clearly superior.

[fiveoh]

To me not spending principal is about security. I dont want to get to 75, have a huge bear market and run out of money. Obviously this can be achieved with growth as well but like Alex mentioned, I feel dividends will fare better in a downturn. I'm willing to work a few extra years if need be to accomplish this. Your plan does make sense and if you are comfortable with that, go for it!

[Kerim]

(01-23-2014, 08:36 PM)cannew Wrote: What happen to the DG? Why have you not factored in the growth of the dividends.

Again, I left out both inflation and dividend growth for simplicity -- it is only a crude illustration to make a point. I understand and hope that dividend growth exceeds inflation. And if that is true, then in both scenarios, reality will be better than reflected.

(01-23-2014, 10:08 PM)fiveoh Wrote: To me not spending principal is about security. I dont want to get to 75, have a huge bear market and run out of money.

Believe me -- I agree completely and hope that I'll reach that magical point where my portfolio is large enough that I can live off of the dividends only. But realistically, that may be a huge number, and many may not ever get there. If you are lucky enough to have the right combination of time and excess capital to invest, you may get there. But many may not.

[EricL]

I think its easy to assume after a 5 year bull market that pulling from principal "capital gains" and taking cash dividends from a portfolio is essentially the same thing. The problem is when you have a year or two of down markets you are really killing the golden goose.

Dividends are about as sure a thing as you can get in investing, especially when you have a diversified portfolio spread across sectors to spread risk. There are nearly 500 companies on the David Fish's CCC List, it really isn't that hard to build a portfolio that yields 4% and produces a dividend growth rate greater than double the rate of inflation.

I think one of the most important things to do to prepare for retirement is first to get out of debt so you don't have all of the monthly payments. With no mortgage, car payments, student loans, etc. you can really live a pretty comfortable life with a reasonable income, especially if you are willing to move to a part of the country with low taxes. Also keep in mind that once you hit retirement you won't have the monthly contributions to the retirement account as well and if you are 62 you have S.S. supplementing your dividend income.

Finally, who says that retirement has to be an all or nothing ordeal? My dad "retired" a couple years ago and now is a free-lance leather-worker and upholsterer. Another I know helps out with tax preparations in the spring and makes decent money in a couple months. Another is an avid gardener and has discovered people will pay good money for him to till up their gardens in the spring.

Anyways, there's no perfect answer to the question. You have to do what you are comfortable with. Retiring with a $1M portfolio puts you well above the majority of Americans at that stage. If you've been smart enough to accumulate that much, I have no doubts you'll be smart enough to make it last as well =).

[Dividend Watcher]

Kerim, I swear you are controlling my webcam and watching what I'm working on. You seem to always jump in ahead of me on the same topic when I'm thinking of something lately.

I just started working on a spreadsheet a couple nights ago of our expenses currently and what I expect will change by retirement. Then plug in projected SS and the projected dividends on our current portfolio. So far, we'll only need less than 1% of our portfolio (obviously dividends) for the first few years unless we do something extravagant but I'm still thinking out some expenses we may have to incur. Of course, our expenses are much lower. If we had to spend $50K per year, I don't know what we'd do.

I tend to think many DGI'ers won't reach the goal of living off the dividends alone. I reached the conclusion that we probably won't make it about a year into DGI. That's still a goal and keeps me disciplined to search for fairly valued companies that pay a growing dividend. It's not that it's not possible, I just don't think too many are that disciplined early enough to reach that goal.

I agree with Alex, either capital or dividends are about the same in theory. The danger lies when withdrawing during a large or prolonged market downturn -- especially over several business cycles.

[fiveoh]

(01-23-2014, 10:27 PM)Kerim Wrote:

(01-23-2014, 08:36 PM)cannew Wrote: What happen to the DG? Why have you not factored in the growth of the dividends.

Again, I left out both inflation and dividend growth for simplicity -- it is only a crude illustration to make a point. I understand and hope that dividend growth exceeds inflation. And if that is true, then in both scenarios, reality will be better than reflected.

(01-23-2014, 10:08 PM)fiveoh Wrote: To me not spending principal is about security. I dont want to get to 75, have a huge bear market and run out of money.

Believe me -- I agree completely and hope that I'll reach that magical point where my portfolio is large enough that I can live off of the dividends only. But realistically, that may be a huge number, and many may not ever get there. If you are lucky enough to have the right combination of time and excess capital to invest, you may get there. But many may not.

I agree. My wife is supposed to get a pension if she works till 50 or older. If it wasn't for that we would need to save a MUCH larger amount. I'm not sure that I'd want to work an extra 10-15 years to not draw down my principal. However, if it was only 3-4 I probably would.

On a side note, how many of you guys are planning for SS in your calculations? The consensus among financial planners seems to be, it wont last a long time in its current state.

[Robandcindy2]

"Assuming a 4 percent yield, if you are unwilling to touch the principle, you’ll need a nest egg of $1,250,000 to fund 40 years of retirement at $50,000 per year. If you are willing to burn up the principle, you’ll only need $1,000,00"

Clearly the first question sometime in your 50's is "What do we believe our living expenses will be when we retire?"

This is followed closely by "what income can we count on?"

The difference between these numbers is the cash flow that must be generated by our retirement investments or by the selling of the investments themselves." The latter eventually being a losing proposition from the perspective of lower dividend income.

Unfortunately this problem really needs to be worked backwards: income needed less known income equaling income stream required. The gross portfolio number required to provide that stream IS the number.

If we cannot attain THAT number (late start to savings, too many children, expensive life style, whatever) something will have to give....available income, retirement spending, life style, etc.

So, yes we can retire on less by touching the principle. That MAY become the only survivable option depending on the curve balls life throws at you. I would prefer to accept what numbers I have achieved, what those numbers provide, then adjust my life style and expenses accordingly.

Why I wasn't "briefed" on the time value of money as a high school student is beyond me....you can bet my kids hear about it like a broken record.

If you have an iPad, here are some helpful Apps to "play with the numbers":

Retire Plan App

Retire!

Good luck to us all....and Ms. Yellen.

Have a good weekend!

[Dividend Watcher]

(01-24-2014, 11:18 AM)fiveoh Wrote: On a side note, how many of you guys are planning for SS in your calculations? The consensus among financial planners seems to be, it wont last a long time in its current state.

I am. I think any politician that votes to curtail a major portion of SS payouts is writing their political obituary. They can do some tinkering around the edges to improve it but I don't think they have to political will to do even that.

[Kerim]

(01-24-2014, 11:18 AM)fiveoh Wrote: On a side note, how many of you guys are planning for SS in your calculations? The consensus among financial planners seems to be, it wont last a long time in its current state.

I'm saving as much as I can in any case, so it is not as if I am saving less than I could because I am "counting" on Social Security. If there is some Social Security in my future, then things will be that much easier; if there is not, then I'll have to make do with what I've saved.

(01-24-2014, 09:40 PM)Robandcindy2 Wrote: Why I wasn't "briefed" on the time value of money as a high school student is beyond me....you can bet my kids hear about it like a broken record.

Amen!

[mjs_28s]

(01-23-2014, 09:20 PM)hendi_alex Wrote: For a pure growth portfolio, selling shares does not equate to drawing down the principal. If growth is greater than the value of liquidation each year, then the growth portfolio could also fully fund retirement without drawing down the principal from its initial value at the start of retirement. Personally, I don't really see any difference. Dividends paid out are essentially 'return of capital'. Either way, spending dividends or selling shares moves the portfolio from the accumulation phase to the distribution phase. To me the real problem with the growth portfolio comes when distributions must be taken during a harshly down market. During those times, IMO a dividend portfolio is clearly superior.

Unless you are taking profits in all the up years and taking more than what you need then you end up selling in down years quite often. Also, up years after even one down year can still be far from you breaking even.

The DJIA counting dividends, was down -5.23%, -4.6%, -16.54% in 2000, 01, 02. In 2003 it was up 31.54%. looks great but if you were needing to take principle in addition to dividends or just principle then you are hurting pretty badly.

If you spend a fixed $50K per year and started with $1M in 2000 by then end of 2003 you be down to around $648K. Well, $648K needs a 54.3% return year just to reach your original investment. in 2003 you got 31.94, or you went up to $854,970 but you took out $50,000 so net $805K, or still needing a 24% year to break even. With 2004, 2005 giving you 7.1% and 1.75% you are down even more again.

That is the problem that is over looked by the principle only arguments. It can work if you happen to own all the right stuff but that is much more often NOT the case. If people owned the right stuff most of the time then investors would not do so horribly on average.

My spreadsheet that I have has the DJIA and S&P 500 back to 1958 thru end 2013 including dividends and you often have two years or more of poor performance. And, even after the poor years when you have a good year or years in a row it is often not even close enough in performance to reach par let alone perform well enough to also compensate you for inflation.

Since nobody can predict the future, I would suggest trying to get 80% or more of your retirement income from dividends alone in order to minimize selling of capital until you are in your late 70s or early 80s. Waiting that long you will probably have your money, even taking principal, outlive you. Starting that as part of a regular retirement in the early to mid 60's....ouch! you could live another 30+ years and half of those being broke.