There is a raging little argument going on over at Millennial Revolution. It’s over living off yield vs living off growth. Wanderer loves his “yield shield” and “cash cushion” and Big ERN is a growther through and through and claims living off yield is a mirage. I’m with ERN on the yield argument but I think there is merit to a tweaked cash cushion approach as well. My cushion tweak is to use an efficient frontier tangent portfolio instead of cash, so it grows in growth years efficiently but does it’s job in down years of protecting the portfolio against early SORR. My tweak also is once the tangent is out of money do not refill it just move to start living off the higher risk portfolio.
Here is 30 years of S&P 500 returns starting in 1988, 5.1% plus 2.245% yield for a net reinvested inflation adjusted 7.35% annualized return!
Here is 20 years of S&P starting in 1998 1.7% growth, 1.9% yield for a total of 3.626/yr total return.
here is a 2008 to 2018 look see, 9.366 growth and 2.281% yield for a whopping 10 year reinvested growth of 11.647% Reinvested yield is a supercharger! $1,000,000 at 11.647 becomes OVER $3,000,000 in 10 years. $1,000,000 at 9.366 becomes $2,440,000 in 10 years plus
281K of compounded dividend interest for a net 2,721,000. If you lived off the yield you would have on the average 28K/yr to live on. If you lived off the growth 3M-2.4M = 600K over 10 years = 60K/yr. Both portfolios after 10 years would be 2.4M
In the 20 year case 1M would grow to 2.04M over 20 years @ 3.636. If you lived off the yield you would live on 23,000/yr and the end portfolio value would be 1.18M. If the reinvest guy winds up with a 1.18M portfolio after spending some WR he could could live on 43K/yr. Both portfolio’s after 20 years are worth 1.18M . If the reinvest guy lived on 23K/yr he would have a portfolio worth 1.38M , 200 grand more than the yield living dude.
It is what it is. Reinvesting the yield is like a dollar cost averaging a yearly cash infusion. The good thing about yield is it tends to be non correlated with S&P growth, so you DCA pretty much the same amount each year whether the S&P is high or low, so some years you buy low, some high but you’re always buying and allowing that dividend money to be exposed to growth. On really good years your growth on the dividend way out performs your WR so only some % of the dividend is extracted and the rest just continues to grow, and grow and grow. In the down year you would prefer not to sell so have some low risk tangent frontier portfolio around to sell instead. I once was enamored with dividend stock scenarios till I did the math. You can goose yourself into using “high dividend stocks” but those can be dangerous and tend to be in concentrated sectors. GE paid a good yield till it didn’t. In the meantime it lost nearly ALL of it’s value. A yield shield doesn’t shield anything of the company goes into negative growth.
I’m with Big ERN except I include the ability to use tangent funds on years the market is down (YTD less than zero) to live on, and still reinvest the dividends when the stock price is low. Do that for a few down years especially in the first half of retirement an u gone b a winner!
10 Replies to “Yield Shield Schmield”
I agree with the growth portfolios.
That is why I am buying those All In One Funds that rebalance themselves. As you often say, it is the buying during the drops is where you make the money. It is also the most difficult to do behaviorally.
I also built a modest safety floor made up of government benefits and GICs in my tax deferred account. Safety is expensive due to the low interest rates so I made sure not to build a large floor.
Bucket strategies miss the buying during the drops which probably do not allow it to keep their returns aggressive.
The problem with bucket strategies is they siphon off growth from high growth to low or no growth, making them unidirectional, so you never buy low. It’s like one hand clapping.
This really opened my eyes a bit because in my mind I was trying to build a portfolio that gave me a safe income floor and thought if I could get that without having to consume capital (i.e. living off yield or distributions from real estate investments), that I could potentially have a goose that lays golden eggs forever.
Was surprising to see that the other method can leave the individual a higher balance and have a larger withdrawal each year.
The thing people miss is if you invest $1000 and it grows @ 6% in 30 years it’s worth $5700. It doesn’t matter if the 30 years starts when you are age 30 or age 60. That’s why I’m stashing cash in a Roth at age 67, to let it grow unmolested until it’s needed. There is no “safe” income floor except maybe TIPS and a huge portfolio. If you own real estate and the economy takes a 15 year dive, you’re just as underwater as the guy who owns the S&P especially if your “investment” is leveraged. Eventually the dividend stream will dry up also. Companies do their best to not cut dividends because it decimates stock price but if the well is dry, the well is dry.
I had never heard of the Yield Shield or Millenial Revolution until this post. During the accumulation phase of my career, my plan was actually similar, create a portfolio of cash dividends that would act like an annuity in perpetuity. But balancing risk vs. yield, I gravitated towards dividend growth stocks on the equity side and safety on the bond side so high-yield and preferred issues never held much appeal. Essentially, to achieve an annuity-like portfolio it would have to be larger given the lower yield. Functionally, I’ve ended up with portfolio not too dissimilar from the Dobermans of the Dow that you examined in the Old Chain Saw post. This seems to provide a reasonable balance between yield and growth. I do appreciate your admonition on the high dividend stocks like GE. I had my own experience in the past with AIG. I learned not to try and catch a falling knife! The Yield Shield is a little too risky for my tastes.
I do agree that reinvesting yield is a supercharger, that’s essentially how I got to FI. I am intrigued and curious about about your withdrawal examples. The yield dude just takes his dividends to eat. But in the 10 year SP500 example, wouldn’t the growth dude have to wait until the 10th year to remove his $600K to take full advantage of reinvesting the dividends? If the reinvest guy takes some fixed discount off of the yield or some SWR of the total, then I can see some extra being reinvested providing a modest performance boost as described in the second scenario of the 20 year example.
In a vacuum, these are interesting ideas. Unfortunately, tax law comes into play. RMDs start at 3.65% from age 70 and only goes up. That’s higher than my portfolio yield today, so in my case that would definitely force selling off equities as I age. I would rather do it on my schedule and not the IRS’s. I do like your ideas of parallel portfolios to provide some SORR insurance and having a TIRA at 70 with 100% bonds to tame the RMD issue. Some things to consider as I prep for retirement.
If you use a FV calc (https://www.calculator.net/future-value-calculator.html) and plug in 1M A 4% and then take out 40K/yr you will always have 1M and 40K per year. This is the dividend argument. The problem is that scenario doesn’t exist. What exists is variability. The 1M actually goes into stock which is property and it’s cash value is set by the market/ Any year the property’s value goes up or down. The way you make money is to take the dividend and buy more stock, turning that cash into more property. So if you own 1000 shares @ 100/share and make $1000 dividend you can now own 10 more shares or 1010 shares. In an upward market the stock appreciates lets say by 30% so your 100K which became 101K because of the dividend purchase (100 x 1010) now becomes 130 x 1010 or 131,300. Your original 100K paid you 1000. If you kept your $1000 and let the shares stay at 1000 your new portfolio would be worth 130K (1000 x $130) so so the dividend portfolio grew 30% and gave you $1000 cash The invested portfolio is worth $300 that the dividend portfolio to raise $1000 to live on you only need sell 7.69 shares and the other 2.31 shares are still in your account. You do the same next year The dividend portfolio pays you $1000 but the growth portfolio pays you 1002.31 so you made the same 1000 in each portfolio to live on but in the growth portfolio you you can buy more shares because you were paid more money. In an upward market that little bit of extra growth just keeps on growing and every year you have to sell less and less appreciated shares to make your nut. In a down market you get to buy a whole bunch of extra shares and when the whole bunch appreciates you need to sell even less to make your nut. In a down market you need an alternate source to live on which is why you own bonds and say gold. You sell what is relatively high. You’ve been putting money into bonds (buying bonds low and selling stocks high) yearly but when the market dumps you sell bonds high or gold high and instead of selling stocks you buy stocks low with the dividend and use some of that excess bond money which is now high for your cash. Since you didn’t sell stocks but bought stock that extra 2.31 in stock is intact and still paying you excess dividend. This is just the “horrible AUM” story in reverse. The “horrible AUM” steals your money why the SOB wants 1% but you can DIY for .5% The “horrible AUM” costs you every year some fantastically compounded amount over decades. Alternatively the benevolent extra you make by not spending all of your dividend but reinvesting at least some of it grows the pie. In essence you are pulling out only part of the growth to live on and letting part of the growth grow. If you always buy low and sell high you win. To do that you need to always have something high to sell, be it a little dab of appreciated stock, a little dab of appreciated bonds, a little dab of gold or some combo. I look at dividends as relative diversity. In up markets they get paid and in down markets they get paid until things get really bad so their correlation to the market is pretty much zero. Whenever you get non-correlation there is an opportunity to make excess profit because it reduces the overall portfolio risk and less risk = free money. If you are constantly siphoning off the dividend it is not available to provide the boost from non-corrleation. Non-correlation between assets is the whole bread and butter of the efficient frontier and what makes it efficient
I don’t think I explained this very well so maybe I’ll try to write something a bit clearer on it.
I followed the initial post, but my head is spinning a bit on the replies which I’ll have to parse out and reread a bit later to allow the lessons to sink in.
Definitely in the camp of reinvesting dividends for the reasons you lay out.
Are all FIRE bloggers required to have snazzy rhyming investing strategies?
only if you’re a cool tootin’ daddyo on the modern day jazz patio. Rhyming goes with the stupid bullet point technique for click bait
Think of it like this if you have 1000 dividend and you live on it, it’s gone and the only growth you get is what ever the stock price appreciates if it even does appreciate. Stocks are property and the amount of property is constant in that scenario. In the dividend invested strategy your property grows. If the market goes up to get $1000 you sell a little of the appreciated property. So if the dividend is 3% you get 3% return and it’s gone. If the market grows 6% and you sell 3% worth of that growth you still have 3% invested and growing next year and the year after that etc. Remember the growth that made you wealthy was the acquisition of property. Buffet doesn’t live off dividends and he doesn’t pay any dividends, Buffet lives off growth.
In 2008 we were headed for depression. Through fancy financial engineering we just wound up with a recession, but that expanded balance sheet still exists on the Fed’s books. The fed tried to normalize this problem but the market rolled over. What happens next time? I’m glad your yields held up and survived an 18 month US recession in Singapore, but the problem with yields is they are the last to go and once gone they never come back. Suppose it was a 36 or 48 month recession? Suppose it was an actual depression? Do you think your yield shield would still be paying 4%? Do you think they would be paying any %?. An example The S&P over 20 years returned 2.02% with 1.9% dividend, a far cry from 4%. 2007 to 2019 it returned 4.1% and 2.2% yield. 2008 to 2019 it returned 7% with a 3.2% dividend. In 1999 to 2008 it returned -3.76% and 1.5% dividend. Cherry picking 2008 (the market low) to 2019 (the market high) does not give me any confidence in your argument.