By Dr. Jim Dahle, WCI FounderToo many novice investors are not familiar with the dividend irrelevance theory. This theory arises out of work done back in the 1960s by Franco Modigliani and Merton Miller. There was even a Nobel Prize won for this and related work. I guess you don't have to believe in this theory (even though I think you should), but it seems silly not to understand it if you're interested enough in finance to be reading this blog.
What Is the Dividend Irrelevance Theory?
The theory is that the dividend of a particular corporation should have little, if anything, to do with its stock price. A company's ability to earn profit and grow those profits is what determines its value, not its dividend payments. Investors are no better off owning a company that pays dividends than one that does not. Given tax laws, they might be better off owning companies that DO NOT pay dividends.
What Are Competing Theories?
Perhaps the most significant competing theory is one that is sometimes called the Bird In The Hand Theory. The idea here, one propounded by so-called “dividend investors,” is that investors prefer to get cash in hand, a dividend, rather than just having the value of their shares increase. Arguments for this theory vary, but they usually sound something like, “Management can lie about profits, but it can't lie about dividends.”
Sometimes arguments are made that dividend-paying stocks have higher returns than non-dividend-paying stocks, and there is some truth to that. But not for the reasons most people think. For some dumb reason, some people also mistakenly think they can only spend income in retirement, and so they give unnatural preference to investments that provide income.
Taxes can also come into play. If tax rates on dividends were dramatically lower than tax rates on capital gains in a particular country or state, dividends would make a lot more sense than they do under our current tax scheme.
A better argument is that when a dividend is paid, management is saying, “We think you have a better use for this money than we do.” I actually like this argument because that's how I run my own business. When I want to invest in my business, I keep earnings in the business. Theoretically, I can get a very good return on that reinvestment, or I wouldn't do it. When the business generates more cash than I know what to do with, I pull it out and invest it elsewhere. However, I am skeptical that most publicly traded company CEOs are doing this the same way small business people do.
Maybe they are, though. Maybe that's why companies often change over time from growthy, non-dividend-paying companies to valuey, dividend-paying companies. However, none of that changes the fact that earnings are earnings, whether paid out to the owner or reinvested in the company.
More information here:
Why So Many Non-Qualified Dividends? Let’s Look Through My Tax Info to Figure It Out
Why Getting a Dividend Should Not Be Exciting
A Dividend Is Not Dessert
Some novice investors mistakenly think a dividend is the financial equivalent of a free dessert. You had dinner with a stock price increase, and now you're having dessert with the dividend. Sorry, that's now how the accounting works. Just boil a corporation down to its essential elements, and you'll see why.
Let's say you own an entire company. At the end of the year, the company has made $500,000 in profit. As the business owner, you can leave that $500,000 in the business, or you can take it out of the business and call it a dividend, or anything in between. You can either own a business that is now worth $500,000 more, or you can own the business plus $500,000 in cash. Same, same.
Why Do Dividend Stocks Outperform?
While this hasn't been true for a while, data over the long term shows that stocks that pay dividends DO have higher long-term returns. However, this isn't because they pay dividends. It's because they're value stocks. That means you're spending less to buy a dollar of earnings than you otherwise would be. A growth stock is like Apple. Everybody knows it's a great company, and it often grows quickly. The investor is willing to pay more for a dollar of earnings because it thinks the earnings will grow faster. It's sexy to own and sexy to work for.
A value stock is like Procter & Gamble. It's not sexy. The company makes diapers and laundry detergent. Nobody grows up and says, “I want to work for Procter & Gamble.” And Procter & Gamble is actually pretty growthy compared to most value stocks. Its PE ratio is 22.4. (Apple's is 34). The Vanguard Value Index Fund PE ratio is about 20 right now. British Petroleum has a PE ratio of about 12. So you can pay $12 for a dollar of earnings with BP or $34 for a dollar of earnings with Apple.
Not over the last 10-20 years, but over the very long term, value stocks have outperformed growth stocks. That's probably because they are riskier. They're more likely to go out of business. They're also not sexy. Nobody can brag about them at a cocktail party, and it turns out that's actually an important factor for some deluded investors. Value stocks are much more likely to pay a dividend at all and to have a high dividend yield compared to a growth stock. So, most “dividend stocks” are value stocks. But dividend yield is not really the best way to select value stocks. Price-to-book ratio and other financial valuation numbers are much better.
More information here:
The Nuts and Bolts of Investing
Investing Doesn’t Have To Be Complicated
Tax Implications
Dividends are actually really dumb tax-wise. In the US, we pay the same tax rates on dividends that we pay on capital gains. However, we get to control when we realize capital gains. The company gets to decide when it issues a dividend. If you wanted to keep your taxes low, you'd prefer to only have investment income when you want to spend it, like during retirement years, rather than during your earnings years. All else being equal, you're better off “declaring your own dividend” by selling some shares than you are having the company send you a dividend when it wants.
Another tax benefit of declaring your own dividend is that the entire dividend is taxable, but that's not the case when you sell shares. Some of that share price is “basis”, i.e., money you paid for the stock. Basis isn't taxable. If you sell $100,000 worth of shares and the basis is $40,000, you only pay taxes on $60,000 of capital gains. That reduces your tax bill by 40% compared to the dividend model. But wait, there's more. You can CHOOSE which shares you sell. Maybe you choose to sell the shares you just bought 18 months ago. The basis of those shares is $90,000. Now, you get to spend $100,000 but only have to pay tax on $10,000. Awesome!
But wait, there's more. When you die, your heirs get a step up in basis. If they sell $100,000 worth of shares the week you die and their basis is $100,000, they pay NOTHING in taxes. That's way better than getting a dividend. Same thing if you give stocks to charity. Let's say you invest $100,000 for charity. It pays you big dividends every year. You pay taxes on those dividends and then reinvest what's left in more shares of stock. Eventually, you give the shares to charity. But if the company had never paid dividends, you would have saved a whole bunch of money in taxes, and the charity would have received much more benefit.
The Bottom Line
Dividends are not a good thing. They're irrelevant. Before tax. And after tax, they're generally a bad thing. You need to understand this as an investor so you can make proper financial decisions.
Do you believe in the dividend irrelevance theory? Do you like getting dividends? Why or why not?
What you’re saying is standard financial theory. But does it fit well with another theory?
That theory is as follows. Eventually all companies go bankrupt; cap gains is zero. What remains of any company is the cash that the company disbursed to its shareholders, when it was in existence. People talk about stock buybacks, which increase share value. But eventually share value equals zero, as mentioned above. What’s left is the dividends that a company distributed to its shareholders.
How does one reconcile the two theories?
You can declare your own dividend by selling some shares. No need to have the company create a taxable event for you in a non-retirement account if you don’t need current income right now.
Competently run companies can last quite a long time. The Hudson Bay Company, the Dutch East Indies company, Nintendo, etc. Sears Roebuck was doing Amazon’s distance order, ship it to you, “everything store” business a century before Bezos opened his online bookstore (and then turned it into a sketchy Alibaba competitor).
Sure, Kodak and Sears eventually failed. But that seems more of an argument for investing in broad based, low cost index funds rather than an argument to seek out “dividend aristocrats” or some such nonsense.
The Hudson Bay Company as we know it only dates from 1869 and is now bankrupt. Before then, it was a monopoly chartered by King Charles II which served as the de facto government of what is now much of Canada. The Dutch East India Company had a good run, 1602 to 1799.
One can look to family owned businesses Shirley Plantation 1613 and Zildjian 1623 (Ottoman Empire and moved to the US); but those are not publicly traded. Most names on the Dow Industrials in 1900 are long gone.
The East India Company (EIC) (English then British) was founded in 1600 and lasted until 1874. It was a monopoly and quasi government of what is now India, Pakistan, Hong Kong and Bangladesh.
Whether the dividends are paid out or not is irrelevant. If the company reinvests them or uses them to do share buybacks, the shareholder value increases. The shareholder can declare their own dividend at any point.
But what typically happens is that at some point the growth of the company slows down and, if well-managed, it doesn’t have a better use for its cash/profits/earnings, so it distributes them to the investors and the company starts paying dividends.
You’re buying a stream of earnings, not a stream of dividends.
Park, no offense, but your theory is irrelevant, especially if you own a broad index fund like the S&P 500. The value of the companies in that index is never going to zero.
Never is a dangerous word. See Russia in the late 1910s for details.
Lol….which is why we diversify globally .
@Park,
“How does one reconcile the two theories?”
It’s very simple – Let’s say you have two identical companies worth $10B making the same widgets. Their expenses to make the widgets exceed their income by $1B per year.
Both companies are going out of business at the same rate if neither pays a dividend.
If company 2 decides to pay a $2 dividend, it is just going out of business sooner, so investor 2’s income stream stops sooner.
If Investor 1 creates the same income by selling shares of company 1 it will actually come out ahead. It is also quite possible that the share price of Company #1 will hold up better having no obligation to pay the extra dividend.
Great article Jim. I still hear (too often) docs chatting about building their portfolios to create a cushy dividend income when they retire. Feels like a legacy mindset that needs to be tossed aside. Appreciate your enlightenment on the multi faceted considerations (especially tax!) when understanding that dividends are not the ticket to a comfortable retirement, or a robust portfolio for that matter.
I completely agree with everything Jim laid out here, and my own investing strategy reflects the principles he described. That said, I’ve noticed one practical benefit of dividends that may explain why some people are drawn to them—though it’s really more about psychology than investing fundamentals.
I manage my parents’ investments, and while they are in excellent financial shape (with projections showing they can safely spend more), they remain very hesitant to loosen the purse strings in retirement. What I’ve found is that my dad is far more comfortable spending dividends that accumulate in the money market portion of the account than he is selling shares. Selling stock feels like a loss, whereas spending “income” feels familiar—much like the wage-earning years.
So while I wouldn’t recommend a dividend-focused strategy, I have discovered that for retirees who struggle to spend their money in retirement, dividends can provide a helpful psychological nudge to actually use some of their resources for the things they enjoy.
Yes, there are a lot of people who are hesitant to spend principal as if they are immortal. That’s another fallacy I’m trying to stamp out. It’s obviously not logical. Reminds me of the argument to buy whole life insurance because it is forced savings.
I completely agree with everything in this article, although I don’t think it is the complete story. I think it is ignoring (as one commenter mentioned) the psychology of investors, especially of many retirees. The behavioral finance side of personal finance is very real. First, many people feel like selling shares and consuming the proceeds is like “eating your seed corn”. Not a good thing to many conservative investors. Second, spending dividends received is very different than selling shares when the market is down 10-50+%. Psychologically it is difficult to decide whether to sell shares now or wait another month or two (or 3 or 4…) to see if they rebound. But with dividends received the investor doesn’t have to make that difficult decision. Just spend the dividends and go on with life. The market will do what it will do but the investor will still have the same number of shares and (most of the time) the same (or higher dividend) coming in next year (although obviously companies can and do sometimes cut their dividends). I think it is a mistake to be completely dismissive of the behavioral finance elements of investing. Also, maybe I’m missing something, but it seems to me that people who have the attitudes about dividends (bad) vs. capital gains (good) espoused by this article should invest 100% in growth stocks, but that doesn’t seem to be what most people do (especially if they are below the 32% tax bracket in retirement). Most people have some bonds and income-generating real estate, as well as some dividend-generating stocks in their portfolios. My question is: why have bonds generating interest and Section 199a dividend-generating real estate if they are so focused on the superiority of capital gains? There are clearly other motivations in investing besides the pure numerical superiority of growth stocks & capital gains (e.g., style diversification, lower volatility, ability to stay the course when things get rough, steady income coming in like when employed, etc.). Wise to remember and acknowledge that (and mention those motivations as valid in articles).
I think you’re missing a few things. First, this article is not arguing that dividends are bad. It’s arguing that they’re irrelevant. Those are two very different things.
Second, you say “….with dividends received the investor doesn’t have to make that difficult decision”, I would rephrase that to “….with dividends received the investor doesn’t GET to make that difficult decision”.
….with dividends received the investor doesn’t have to make that difficult decision.
Finally, I would push back on this idea:
“spending dividends received is very different than selling shares when the market is down 10-50+%” with an argument that it IS NOT very different. It’s the same. When the market is down, the company can buy it’s own shares back for much cheaper, perhaps much cheaper than management thinks those shares are actually worth. By paying a big fat dividend because the investors expect it, the company misses out on that opportunity to add value for the shareholders.
I agree this is a psychological thing for people. But you and Josh are arguing that psychological thing is good for investors. I’m arguing it isn’t.
One of the biggest fallacies in economics and in finance is the concept of “homo economicus”, or that people are purely rational, emotionless automatons that are purely profit-seeking and purely utility maximizing. That has been completely disproven, although it still pervades a lot of finance and economics theory. I agree that, in a world where people are emotionless and purely utility maximizing that your approach to personal finance makes complete sense. But I would argue that people are very much emotional people with a variety of other goals and motivations beyond (or in place of) utility maximization and pure profit seeking.
I have to agree with John and Josh here and add that a part of a market downturn can be attributed to irrational herd psychology…. Theoretically the market eventually corrects (sometimes fast, sometimes slow) … but in the meantime a retiree has to deal with psychologically spending or tightening purse strings during a difficult time. A business is theoretically less volatile emotionally … argument why dividend cuts /variation are much more stable than their share valuations.
If you’re using a reasonable withdrawal rate, you don’t have to decrease it during a market downturn. That was the point of all those SWR studies. The withdrawal rate already accounts for the sequence of returns risk.
Look, if you want a stable dividend, you can always declare your own. If the paid dividend is more than what you’ve chosen to take, reinvest the extra. If less, then sell a few shares. Same same. They’re irrelevant. A psychological crutch at best.
John, here is a solution….Behavioral modification: If an investor struggles psychologically to sell shares in retirement, often due to a desire to time the market for maximum gain, they should automate withdrawals and eliminate the need for active decision-making in their portfolio.
Psychologically, it’s different, but in reality it’s the same. If you fail to reinvest dividends when the market is down, it has the same economic effect as selling the same $ value of shares when the market is down. You’re likely better off reinvesting the dividends when the market is down (and therefore expected returns are higher), and living off that 2-3 years worth of cash reserves or some other source.
Stock market return has historically been greater than that of the economy. When I’ve read about how that can occur, the argument is that it is d/t dividends. If people reinvested all of their dividends, it wouldn’t be possible for the stock market to do better than the economy. But they don’t, and that’s the reason for the outperformance of the stock market.
Dividends have tended to decrease with time. Will that decrease the outperformance of the stock market? I can’t answer that question. And where stock buybacks fit into this, I don’t know.
How are you defining the economy, by GDP? So you’re saying the stock market earns 10% and GDP grows by 5% or whatever? I guess the argument would be that publicly traded corporations are more profitable than the average small business or something?
There are a number of reasons why dividend yields have decreased over time. One is likely valuations. People just don’t see stock ownership as being as risky as they used to. There was a time, perhaps 70-100 years ago or so, that people expected stock dividend yields to exceed bond yields. So the price of stocks has been bid up, lowering dividend yields. Instead of PEs of 10, we see PEs of 25 or whatever. Another reason is the taxation of dividends. If it is more tax efficient to do stock buybacks, well, you’re going to see more stock buybacks than dividends. There may be other reasons as well.
You have a misplaced “only,” which changes the meaning of the sentence:
You wrote, “For some dumb reason, some people also mistakenly think they can only spend income in retirement, and so they give unnatural preference to investments that provide income.”
It should say, “For some dumb reason, some people also mistakenly think they can spend only income in retirement, and so they give unnatural preference to investments that provide income.”
Teach me guru. What is the difference and why is my education so lacking that I don’t already know it?
Not that it matters but “people can only spend income in retirement” literally means the only thing they can DO in retirement is spend income because “only” is absolutely limiting what follows. The phrasing, “people spend only income” limits the effect of what they can spend but makes no claims about limiting the ability to do other things in retirement. Context makes the intended meaning clear so you can live a full and complete life while ignoring that distinction. In casual conversation and writing we all make this mistake frequently but it is one of the things I have to check when reviewing regulatory documents like a proposed package insert that have precise meanings.
Some might call you guys the grammar police, but I appreciate the explanation.
I find it interesting that I make a living now writing, but only took one English or writing class in 11 years of post high school education.
Guilty as charged. If hundreds of people were carefully parsing everything I wrote they would find plenty of grammatical and other errors. You are only getting all this nitpicking because so many of us get a lot out of reading your posts and criticism is one way to engage with an author.
WhiteCoatInvestor, I agree that your sentence was confusion and I had to read it twice to figure out what you were getting at. The “grammar police” are absolutely right. But I did enjoy your post about “dividend irrelevance”, something I had not thought about before.
Google “misplaced modifier.” There are many good websites with funny examples. Here’s one:
https://bigwords101.com/2013/blog/a-little-lesson-about-only/
Maybe you were daydreaming about fancy cars during class?
(P.S. You need a comma before “guru.” 😉 And I’m not a guru. Sadly, I’m a jack of all trades, master of none.)
Be sure to tell Warren that the billions he makes in dividend income yearly was a mistake.
Buffett is usually cited as someone who demonstrates dividend irrelevancy because he has only once ever paid a dividend and only returns capital to shareholders by stock buybacks (the one caveat to dividend irrelevancy is tax friction and both stock buybacks and retaining earnings avoid that).
Great Reply !
I personally believe that the dividend irrelevance theorem is incorrect. I do believe that to diversify for lowest risk you need to own both dividend paying stocks and non dividend paying stocks. As in a diversified stock mutual fund. I believe in the “life cycle” effect for a lot of stocks that come into publicly trading status,at first pay little or no dividend,then pay more dividend,and eventually fall into decline and eventually leave the world of publicly traded stocks (and stop paying dividends) R.I. P. Briggs & Stratton (someone else now owns the trademark and does business as “Briggs & Stratton” but it’s not the original business and the shareholders got wiped out in the bankruptcy). I understand that B & S did do share buybacks at times and shareholders who didn’t sell in time got no benefit.
It is unfortunate in my opinion that the present tax system is so convoluted and punishes dividend payments and hard work.
I also think that “buybacks” do not necessarily return value or earnings to the buy and hold shareholder. (I believe I am correct that a corporation can issue new shares that negate the effect of share buybacks unless you sold in time.)
The dividend irrelevance theory does not state that you don’t need to or shouldn’t own stocks that pay dividends.
I was going to say the same thing. Warren has done quite well with dividend irrelevancy stocks.
I was going to say the same thing. Warren has done quite well with dividend irrelevancy stocks.
Probably laughing all of the way to the bank.
I think you misunderstand the point of the article. I know Warren understands it.
Since a year or so, I’m investing in dividend paying stocks ETF in Vanguard and Charles Schwab a cash that resulted for the selling of two rental apartments( why I’ve chosen to invest in installments and not lump sum in another issue). Why Div Pay stocks ETF? Because they are Value Stocks , much more attractive than Growth Stocks, specially the variety international, like VYMI and SCHY whose P/E and P/B are very attractive. Remember that close to 38% of the S&P 500 is dominated by 10 companies, a concentration like this is almost never been seen: this degree of concentration is going to blow in the face of some people, I don’t need to run this risk. Besides I’m retired and need money either from dividends or selling of the investment in the broad market, which holds 80% approximately of my assets. So, in situations like this ( Retired and avoiding the monumental weight of a few companies in the total market, I’m sure there are others) I think makes PERFECT SENSE to invest in dividends paying stocks.
Any particular reason you want your value tilt to be dividend focused instead of price to book etc?
Yes, as I said, I’m retired and need money , either from dividends distribution or selling of appreciated assets of the rest of my portfolio ( the majority, close to 80% in broad index funds). The money to invest is sitting in a MMF and is the result of the selling of two rental apartments. There is a close correlation between Value Stocks and Div Pay Stocks, but I’m choosing the DPS that are attractive by the PE, PB ratio, for instance VYM is attractive (VIG, also a DPS from Vanguard is not), SCHD, from Schwab , is fairly attractive, but specially it’s international versions: VYMI and SCHY are quite appealing. In summary I’m trying to choose the one that pay dividends AND whose valuations are in mid- lower range. Your advice is well taking: DPS are NOT SUPERIOR to Growth, at the end the important thing is after tax money ( capital gain and qualified dividends are taxed the same), in the accumulation phase DPS holds a disadvantage.
If you are concerned about the S&P 500 concentration and feel a value tilt would help That is a very good question .
A fund such as VTV has a 41% by weight overlap with VOO or 12 % with QQQ.
Compared to a passive rule based fund like SCHD which has 7% by weight overlap with VOO or 5 % with QQQ
Which will be better complementary hedge. I guess time will give the answer.
Dividends can, under certain narrow but important circumstances, have tax advantages over capital gains. Specifically, short term capital gains are taxed at normal income rates (bad), whereas long term capital gains are taxed at much lower rates (good). Qualified dividends are taxed at rates akin to long term capital gains (good), whereas ordinary dividends are taxed at normal income rates (bad). To qualify for long term capital gains, the underlying instrument must be held for 365 days, but for qualified dividends, it only has to be held for 60 days (out of a 121-day period around the ex-dividend date). That means that you can (qualified) dividends are vastly better, from a tax perspective, when the investor knows or fears that they will need liquidity in less than a year. It’s a little narrow, but 60 days is a lot less than 365 and I think it’s worth noting in this article.
While everything you say is accurate, I don’t think anyone should be owning stocks for a period of time less than 365 days and probably not for a period of time of less than 5 years.
Daytrading ! “It’s not for me !”
I was thinking the same thing and I agree you!
The only downside I see for dividends in a taxable account is the “tax drag”. You pay tax when it is paid, whether you need it or not!
Thanks Jim. Great article. Agree, they’re irrelevant. Total after tax return is what I care about. Often dividends decrease my return because I wouldn’t otherwise be selling and paying tax in my taxable account.
One thing I don’t see mentioned is qualified dividends. One can get 94K approximately in qualified dividends and owe No tax. I am getting dividends and growth in all 3 of my portfolios.
I’m not sure you understand exactly how the taxation of dividends works. Dividends stack on top. So if you have $94K in taxable income of any kind, dividends above and beyond that are taxed at 15%.
https://www.whitecoatinvestor.com/qualified-dividends-capital-gain-tax-worksheet/
You don’t get $94K in regular income and then $94K in tax-free dividends on top of that.
Interesting viewpoint. I agree with your sentiment in many ways especially taxes. I think from a risk perspective though it’s more nuanced. There’s something to be said for low beta stocks as part of an overall portfolio especially for people with a low risk threshold. I also think you have to look at stocks compared to the market cycle and economic conditions. Some of the best value stocks often pay dividends, but you should invest in them because they’re undervalued and “safer” not because of the dividend. Still capital appreciation. There are other/better tools for safer steady income verses dividend stocks.
Total after tax return is what I care about.
If you look at total after tax return over past 10..20 years etc….Div/value vs growth..growth won pretty easy.
I would agree with 10 and I think even 20, but not “etcetera.” When you look at etcetera, value still wins and is expected to for both a risk reason and a behavioral reason. The pendulum is likely to swing back at some point from Growth to Value and from US to international (this one may be already started) and from large to small.
Dividends are relevant because if companies never paid a dividend (or bought back stick), there is no theoretical reason to invest. There is no other way to pay an investor. Non dividend paying stocks are valuable because of the notion that someday they will pay their investors. It is no different than a privately run business. If I own a business but never plan to pay profits to myself, what is the point?
“There is no other way to pay an investor.”
Sure there are. Stock buybacks, as you noted.
Dividends are a relic from the days of paying high commissions when buying and selling stock. In that situation, dividends made a lot of sense.
I believe you are correct. My understanding is that “buybacks” can be negated by issuance of new shares as in Executive Compensation. Also the defunct Briggs & Stratton I understand did share buybacks that did nothing for investors who didn’t sell in time (the company declared bankruptcy a few days after awarding large “retention bonuses” to top executives) wiping out the value of the stock (someone acquired the name and some of the assets and is now doing business as “Briggs & Stratton” )
For sure it’s easier to manipulate buybacks than dividends in those ways.
The article doesn’t address sequencing risk, which is critical for retirees who can’t survive a long down turn. If the article’s solution is having a cash or cash equivalent for the 2-5 years of a downturn it defeats the purpose of investing for growth.
The article is irrelevant to my situation and will be ignored.
You’re right that it isn’t an article about dealing with sequence of returns risk. Maybe this one will be less ignorable for you:
https://www.whitecoatinvestor.com/4-methods-of-reducing-sequence-of-returns-risk/
Not a fan of solution #1 and #2. I didn’t work 40 years to “spend conservatively or “be flexible”.
#3 and #4 are essentially “taking money off the table”. You may want to look at HDO on seeking alpha. Rida Morwa has a method where you can have your cake and eat it too.
I have 50% of my portfolio in HDO with 9% dividends and total return over 5 years of 5% below the S and P and I live off of the dividends plowing 25% back into HDO. My dividends grow each year, I never have to sell into a down market and the “price” is 5% below market returns while living off the dividends. Better than your solutions in my view.
Note that if you worked hard and saved well for 40 years “spending conservatively and flexibly” should be an awful lot of money.
It is not the point of how much money I have but the best approach to grow and spend money in retirement. I would think you would be open to a better way
Thank you for sharing your opinion that your method is better. I simply disagree, that’s all. It’s not that I’m not open to hearing about it or that I wouldn’t change if I could find a better. I just don’t think your way is a better way. I haven’t convinced you it appears though, and that’s fine. Different strokes for different folks. Many roads to Dublin and bla bla bla.
It seems you have not investigated the HDO method and rejected it out of hand. I just think you could learn a thing or two and be a better guide for others, but that is just the way the world works. People are often not open to new ideas.
Thanks for your time.
@Cordell,
If I understand what you are saying, it is that using HDO works for you. I just disagree that you can make the leap that others need to investigate it, especially if they have something that “works for them.” I have known Rida’s writings for a number of years and even use 5 or 6 of his recommendations, because they work within my strategy, but there is absolutely no way I would suggest anyone should put 50% of their retirement assets in such a strategy, but that is just my opinion and it really depends on the size of your asset pile more than anything. It sounds like what you are saying is that giving up 5% to the market returns with 50% of your assets is ok for you. Maybe I mis-read that, as I’m not sure how you would even calculate that. I personally keep track of each asset I am invested in vs the market in a Morningstar portfolio and track total returns there, but that is a lot of work for the normal person to do, but anytime your assets trail the TR of the market, you are losing dollars to “the market” over time, dividends paid or not. Sequence risk has nothing to do with it. Don’t be so naive that you think you will never have to sell any HDO assets when they are down. I doubt that is in the guarantee in their disclosure statement. When that happens you just lost a bunch of those dividends and your capital.
Well,
We don’t have to keep doing this.
I have 5million. 2.2 million making 9%-11% totaling $350,000 in dividends this year.
The S and P is up 15% this year.
I live on $200,000 per year
My investments are up 9.5%,for 50% of my portfolio and 15% on 50%,excluding the $200,000 I live on.
If you are following my account is now $5.4 million, I live on $200,000 reinvesting $150,000. If you include total dividends, I beat the S and P, when you subtract my living expenses I am up 9%.
Over 5 years when the market is down my dividend stocks are down less.
I am a stock buyer always because of excess dividends.
This is better than anything I have considered, including your scenario.
Thanks for your time and consideration
Cordell
I don’t think we can because your math doesn’t make sense.
In basic terms, the bottom line is I’m not sure where you get your numbers, since SPY is up around 11% and not 15% YTD, but the absolute magnitude is not the issue. Let’s call it an annualized 15% as that sounds about right if the market keeps going.
Common sense would say, using market returns of 15%, then if you put 100% of $5m in the market at 15% it would be $5.75 million and if you subtract 200k that leaves $5.55 million. That is base case for 100% SPY.
Your scenario is you leave half in SPY, get 15% and pull out nothing — leaving $2.875m
With the other half you get a return less than market and after you reinvest the excess you still have only 9.5% return.
Knowing Rida’s investments, there is NO group of HDO investments that are going to have a annualized total return in the long term better than the market, so if their annualized TR (which includes dividends reinvested) is not better than the market putting half of your portfolio in such an investment is not going to lead to more money. This is very simple math.
https://seekingalpha.com/instablog/3752451-financialdave/5287623-is-magic-in-dividends
I have been doing this in real time for over nine years, one portfolio of dividend income and the other of selling shares:
https://seekingalpha.com/article/4747913-high-income-in-retirement-goes-even-higher
Examples:
DMLP up 120% over 5 years,12.5% dividend
MAIN up 115% over 5 years,5% dividend
WES up 320% over 5 years,9.5% dividend
EPD up 80.57 over 5 years,7% dividend
ARLP up 600% over 5 year,10.4% dividend
S and P up 85.17 over 5 years,1.19% dividend
Not all of my positions are beating the S and P , but overall.
Good luck with your investments,
Cordell
If you can repeatedly pick stocks that beat the overall market, even by a little, you shouldn’t just be managing your money.
It’s important to step back from this argument for just a moment to acknowledge how well you’ve done. You’re a pentamillionaire and clearly your strategy WILL work to provide financial security and a wonderful retirement.
The only thing being argued here is whether there is a better one. You don’t NEED a better one of course.
@WCI,
Totally agree. Just like my title better. 🙂
https://seekingalpha.com/instablog/3752451-financialdave/5347859-dividend-what-is-good-for
Sorry, I didn’t clearly state the two huge advantages other than greater total return.
1. I never have to sell a stock so I fully participate in the recovery from a down market.
2. In a down market I live off the dividends, without effecting my investments for the long term.
As I see it I can have my cake and eat it too.
CE
@CE.
1. On my end there is no argument that you have done well, but my question is how long have you been doing the HDO with Rida?
2. How many assets (stocks, CEFs, CLO, REITs etc) do you have in your HDO half of your portfolio, hopefully it isn’t just the 5 shown, that have been picked for their really good 5-year performance?
3. Short-term performance even up to 10 years is not much to go on for a portfolio you may plan to hold for 20-30 years. Here is a look at the maximum Portfolio Visualizer can do, which is 10 years without any withdraws compared to SPY (11.88% HDO to 13.56% SPY:
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=NLppr9OyG5JnTj5cITa8c
4. This 10 year plot has the 9% withdrawal worked into it they you indicated you are withdrawing (200k/2200k)
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&sl=4hMzZg4gimNqSNxC4tRcfJ
Shows your capital is decreasing while SPY capital was increasing under same withdrawals.
I have approx. 40 holdings, 20 HDO and 20 S and P analogs(SPGP,USA RVT,etc)
I am 70 y.o. , I don’t have multiple 20 year periods to invest.
I appreciate your analytical analysis.
I think you are “withdrawing “9% in your calculations because you do not appreciate that I do not want to withdraw\sell my stock position. That is why I want to live off of the dividends alone with increasing positions.
I was 100% in the S and P for 40 years.
I am not willing to run out of income during a protracted downturn.
If there is a 10 year 60% down turn you have to see how that would be a problem.
My dividend stocks may go down, but I don’t have to sell. My only risk is if the dividends are cut.
All of my analysis is to be as sure as possible that that will never happen.
I have been 50% HDO and have lived on 200k/year with portfolio growth from 4 million to 5 million
Pretty happy with that going forward
Cordell
@CE,
We are actually not as different as you might think. I am 73 and only wish I had been in an SPY type index for 40 years, rather than always looking for the next best thing, until I really started to study investing further 15 or so years ago.
You are actually in a great place. Similar to myself, in that even if I spend down my HDO investments, it is only about 10% of my total. Granted your investment in HDO is much larger, but you have other options.
I am only suggesting as a caution you go back and look carefully at my second Chart of an equally weighted version of your 5 investments and see how your portfolio lost half its value in 2020, if you continued to withdraw an inflation adjusted $200k+ from it and it never recovered to its original value even with its steady climb in the last 5 years. The fact that we are both over 70 is actually a good thing since with this split type of strategy ( I actually have 4 different strategies – 2 for TIRA, 1 for Roth and 1 for taxable), it really doesn’t matter if one strategy doesn’t exactly carry its weight as you don’t have to completely neglect using other money. 9% is a lot to draw from any strategy and IMHO it is not sustainable, but like I said it doesn’t really have to be, and I myself have no false security that my very similar strategy will last even though I have had similar results as you have. I have studied a number of dividend strategies over the years, one for over 22+ years where it was easy to track every penny. In 2002-2009 it lost just as much value as the market, even though no money was being withdrawn from it and dividends were being reinvested. Today after 22 years it has trailed the market (SPY) by something like 30% at last check.
Also, I am constantly reminded that as we get older, strategies that involve our input and decision making, such as where to reinvest the income and what to do when dividends drop are somewhat at risk unless someone else has the capacity to take over. That is one reason that in the past month I have reduced my Roth investments from over 30 moving down to about a dozen mostly ETFs with dividends reinvested automatically and will continue to simplify.
Best of luck.
Dave
Dave
Thanks for your thoughts.
I am moving the difference from 397k from what I spend/RMD to a ROTH conversion to keep taxes at 24% max. Pulling the growth first to continue living off the dividends. The plan is to have 2-3 million in the ROTH in 10 years. Then start transitioning the HDO.
The goal is to be done with taxes/ Medicare and otherwise. Hopefully leaving 5million to my six kids.
Good luck to you on your journey!
Cordell
If you’re investing for longer-term holding periods and don’t need dividends for immediate passive income, it really is a tax-efficient way to go. Here’s another situation that’s interesting.
If you are not a tax resident of the US (non-resident alien) and want to invest in US-domiciled equities, an automatic 30% withholding tax is applied to your dividends, unless your country of tax residency has a tax treaty with the USA (more on that later)
https://www.bogleheads.org/wiki/Nonresident_alien_taxation#Are_dividends_taxable_for_a_nonresident_alien?
Guess what though? Non-resident aliens don’t have to pay ANY capital gains taxes on those same holdings!
https://www.bogleheads.org/wiki/Nonresident_alien_taxation#Are_capital_gains_taxable_for_a_nonresident_alien?
As US tax residents, we have things much simpler because qualified dividends and long-term capital gains are taxed at the same rate. Foreign investors have to tread carefully because their US estate tax exemption on their US-domiciled holdings only has a measly $60k exemption…
https://www.bogleheads.org/wiki/Nonresident_alien_taxation#Are_nonresident_aliens_at_risk_from_US_estate_taxes?
The better alternative for a foreign investor seeking exposure to US equities is to invest in, say, Irish-domiciled ETFs. Vanguard offers an S&P500 fund for those investors. You can even buy them in different currencies such as USD, Euros or British pounds. Unfortunately, I haven’t seen any total US stock market funds offered by Vanguard in Ireland.
https://www.ie.vanguard/products?product-type=etf&product-type=mf®ion=usa&management-style=index&asset-class=equity¤cy=usd
Thanks to Ireland’s tax treaty with the USA, foreign investors who are not tax residents of Ireland can invest in mutual funds of US equities and only pay an automatic 15% withholding on dividends to the US government. Ireland itself won’t levy any income taxes on foreign investors who aren’t tax residents of Ireland. Plus these Irish-domiciled investments aren’t subject to estate or inheritance taxes from the USA or Ireland either!
https://www.bogleheads.org/wiki/Nonresident_alien_investors_and_Ireland_domiciled_ETFs#Why_invest_in_Ireland_domiciled_ETFs?
In short, dividends can really hinder you if you have to pay withholding or income taxes on them. Unrealized gains generally aren’t taxed until you actually realize the game. So as WCI and Warren Buffet like to advocate, just create your own “dividend” by selling some of your equity holdings.
“The Power to Tax is the Power to Destroy”
I think the late Mr. Bogle used to like and use that quotation?