Touching The Principal!

[timdman]

I'm fortunate in that my work should provide a pension when I retire. Got about 8 years to go. I'll be 64 so I factor in social security and dividends from my portfolio. When I do, I use 75% of what the pension and SS tells me will be available - better to plan for the downside. At least for the next 20 years, SS should be OK even if benefits are reduced.

[hendi_alex]

For most retirees, I don't think that a majority growth portfolio is a very sound move. But IMO there is room for some weighting, perhaps 10%-20% for lower yielding growth oriented stocks, especially if call writing is used in conjunction with a portion of these holdings.

[mjs_28s]

(01-27-2014, 05:23 PM)hendi_alex Wrote: For most retirees, I don't think that a majority growth portfolio is a very sound move. But IMO there is room for some weighting, perhaps 10%-20% for lower yielding growth oriented stocks, especially if call writing is used in conjunction with a portion of these holdings.

I don't either but according to you, dividend portfolio is the same as growth. Are you changing your mind already?

"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."

You are clearly wrong in your opinion.

[hendi_alex]

I'm saying that it doesn't matter where the cash flow comes from. Whether it comes from selling appreciated shares or comes from dividends is irrelevant. But, as expressed earlier, dividends do IMO have an advantage in down markets. That key difference is why most of my holdings are in fact dividend stocks. However, IMO, the love of dividend stocks should not preclude someone from allocating some weighting to growth stocks which will likely perform better over the long haul.

A retired investor who has the right risk profile may very well be better off with a portfolio which has an emphasis on growth stocks, or at least one where dividend yield is only a minor consideration. One must keep in mind that the main reason that growth stocks pay far less in dividends is because reinvesting in the business is the smartest and best use for that cash. The biggest total return will always come from companies with the greatest sales and earnings growth. The paying of dividends takes away from that effort and therefore hurts overall performance, except in more mature companies which can't find a productive home for the cash.

[mjs_28s]

(01-27-2014, 08:12 PM)hendi_alex Wrote: I'm saying that it doesn't matter where the cash flow comes from. Whether it comes from selling appreciated shares or comes from dividends is irrelevant. But, as expressed earlier, dividends do IMO have an advantage in down markets. That key difference is why most of my holdings are in fact dividend stocks. However, IMO, the love of dividend stocks should not preclude someone from allocating some weighting to growth stocks which will likely perform better over the long haul.

A retired investor who has the right risk profile may very well be better off with a portfolio which has an emphasis on growth stocks, or at least one where dividend yield is only a minor consideration. One must keep in mind that the main reason that growth stocks pay far less in dividends is because reinvesting in the business is the smartest and best use for that cash. The biggest total return will always come from companies with the greatest sales and earnings growth. The paying of dividends takes away from that effort and therefore hurts overall performance, except in more mature companies which can't find a productive home for the cash.

There is so much data that says you are wrong, but ok.

"Whether it comes from selling appreciated shares or comes from dividends is irrelevant." So not true no matter how much you think that. End up with a few down years in a row and if you are using pure capital you are screwed.

"One must keep in mind that the main reason that growth stocks pay far less in dividends is because reinvesting in the business is the smartest and best use for that cash." An assumption that is not always true.

"The biggest total return will always come from companies with the greatest sales and earnings growth." Always? Pretty big stretch. You might want to reread the part of The Future for Investors about the growth trap.

"However, IMO, the love of dividend stocks should not preclude someone from allocating some weighting to growth stocks..." Nobody said that so why bring it up. I think pretty much anyone you would ask here already agrees with the point of some growth stocks is a good thing.

But you are trying to speak both sides of the argument. You believe that where income cash-flow comes from does not matter when clearly it does. Having to sell to cover all your expenses with a bad down year, a few down years, or even a few flat years in a row is a journey to hoping you die before running out of money.

Typically growth stocks are obviously already known and their PEs are high. The return of high PE stocks over time is lower than that of lower PE stocks. The returns of non and low dividend payers is typically lower than that of higher dividend payers. Stocks for the Long Run has five decades of data to back this.

For example, the S&P500 broke into quintiles from 1957 to 2006 shows that the highest dividend payers had a annual compound growth rate of 14.22% compared to 9.69% of the lowest / non dividend payers.

The stocks in the quintile with the lowest PE ratios compounded at 14.3% for those five decades while the stocks in the "middle" range of the PE ratios were down to 11.11% per year. The highest PE stocks returned 8.90% compounded per year.

Really, the best way to play growth stocks is to be there before people find them. The high PEs mean one of two things - people already found them so the price has already been run up and thus, you miss much of the return. Or, the stock in question just barely started making a tiny profit and was priced high due to people's anticipation of this occurring. I suppose you could add that if your "growth" portion was focused on the small cap sector then you are probably going to be ok, but even then you can still have several years in a row of low or negative performance that murders the principle.

The beta on the highest yielders is 0.9 while the beta on the lowest quintile pe stocks is 0.63. Higher return for boring, lower pe dividend payers with less risk.

[hendi_alex]

The tone of a board often steers individuals in extreme ways. Obviously there is a love of dividends on a dividend investing board. IMO it is healthy to have some discussion of growth allocation, growth candidates, other investment vehicles outside of the typical DG exposure. It would seem prudent to me, that for diversification sake, a person should view DG exposure as an investment class whose portfolio weighting should be determined based upon the individual's circumstances.

For our portfolio there is an emphasis on dividend stocks. The stocks are usually chosen based upon yield and distribution coverage rather than DG considerations. I visually scan the dividend history, but don't attempt to quantify growth rates. For me, current yield is more important than dividend growth. Stocks with 3% and lower yield simply hold no interest, as my target is to average near 6%. It has now become very difficult to do that without taking on too much risk. Any lower yielding positions are generally used as covered call plays in order to boost the cash flow yield above 6%. Because of our focus, very few DG stocks are under consideration, and even if they are, just as covered call plays. I will eventually buy some DG stocks, but only when the yields generally move into the 4%-5% range or higher. IMO we will see single digit p/e's again, and that will be the time to make a significant adjustment to our portfolio structure.

[ken-do-nim]

This is a fantastic topic and I'm so glad I found it, because I was going to start a similar thread before I decided to do a search.

There's a healthy discussion here about the danger of drawing from your growth portfolio, due to down years, but it seems to me there's an equal concern about dividends that get cut. We've seen BP and Dominion cut their dividends in recent years. I'd hate to see someone get that minimum $1,125,000, retire, average out to 4%, but then have certain key stocks cut their dividend rates and the average falls to 3%. I guess that would force you into the hybrid approach described where you get the dividends you can, and supplement with liquidating principal to supply the rest. (To be honest, I think you'd want double that - $2.5 million - at age 60 to feel confident that you can retire and weather future financial storms. Also the 4% dividend is taxed, and the $50,000 expenses are presumably after-tax, so even without financial storms $1.125 million is too low, though I realize Kerim was just proving a point not trying to showcase an example nest egg amount.)

Also ...

"The stocks I hold have consistently provided an increase in the dividends paid and I am currently receiving over $60,000 annually." - wow! And that was back in 2014. Cannew if you're still around I'd love to know how much you are receiving now. That's the highest total I've seen someone mention here so far.

[crimsonghost747]

Indeed a great thread.

I've been thinking about this a bit lately, and I came to the conclusion that while I absolutely cannot reduce the portfolio value with withdrawals (too long of a retirement time... hopefully), with a 10% average dividend growth for the portfolio, and inflation being around 2% (average), I should be able to comfortably sell 2% or 3% of my portfolio every year. (in addition to withdrawing the dividends)

The dividend growth would account for the inflation and the tiny reduction in share count, so even while selling 2% yearly from my portfolio my buying power from dividend income should still increase slightly on average.

And the additional 2% of total portfolio value would be quite a handsome addition to my budget... my portfolio currently yields around 3.5% so that would increase my income by over 50%, with the downside of limiting buying power growth.

This is my strategy for potentially withdrawing tiny amounts annually without completely compromising inflation adjusted dividend growth. It works in theory, as long as my holdings keep bumping up the dividend and inflation doesn't skyrocket.

[ken-do-nim]

I'm thinking along similar lines, except I think by the time I'm 60 my portfolio will be 80% dividend producing growth stocks, and 20% pure growth stocks and ETFs, and it is from that latter 20% that I will trim from during up markets. So in a good year, I'll have my full income and enjoy a nice lifestyle, and in a down year, provided dividends aren't cut as well, I'll still have most of my income but will have to cut back a bit; maybe one vacation instead of two and less dining out.

[MikeWa]

You shouldn’t account for only regular living expenses. Once in retirement, a healthy buffer in either cash reserve or additional income stream will be needed for emergencies. What if you need to replace a car or you or spouse gets sick and need a special treatment? There may be a need to cover long term care expenses in either a facility or by hiring nurse.
These costs will quickly drain your portfolio if they come from principal.

[fenders53]

(03-03-2021, 08:55 AM)MikeWa Wrote: You shouldn’t account for only regular living expenses. Once in retirement, a healthy buffer in either cash reserve or additional income stream will be needed for emergencies. What if you need to replace a car or you or spouse gets sick and need a special treatment? There may be a need to cover long term care expenses in either a facility or by hiring nurse.
These costs will quickly drain your portfolio if they come from principal.

Good points.  Just for this reason I intend to start retirement with a newish vehicle and a couple more things I know I will "need" for the quality retirement I've always planned. 

A few more considerations.....

-If you have another income source such as pensions, rental income, or even an intermittent part-time job, best to plan your budget so these sources could get you by for a few years early i retirement if the market goes to hell.  I'd like to believe widespread dividend cuts could never happen, but we can't know that for sure.  If your port goes 40% off that would be a horrible time to be selling off shares to live.      

-It's likely I will have good enough health at age 60 to fully enjoy retirement life.  Health at age 70 is far less certain, and even being alive at age 80 might be in question.  I'm not planning to leave this world with all my capital.  I'll make sure my heirs have some assets, and now and then I will take a chance and spend a little money while I can enjoy it.  I gave up a lot of luxuries in life to be in my current financial situation.  A long way around saying "you can't take it with you".

[ken-do-nim]

(03-03-2021, 08:55 AM)MikeWa Wrote: You shouldn’t account for only regular living expenses. Once in retirement, a healthy buffer in either cash reserve or additional income stream will be needed for emergencies. What if you need to replace a car or you or spouse gets sick and need a special treatment? There may be a need to cover long term care expenses in either a facility or by hiring nurse.
These costs will quickly drain your portfolio if they come from principal.

Great point.  The ideal state is probably:

1) A dividend growth portfolio that takes care of 100% of your income needs (or if it doesn't, you also have say rent coming in)
2) A pure growth portfolio that is just allowed to grow, but can be tapped when the need arises
3) A healthy cash reserve