[Editor's Note: This post was originally a Pro/Con post. Anytime someone participates in a Pro/Con post, I always offer the option to not run it if they're not satisfied with how it turned out in the end. In this case, the writer for the Pro position decided he didn't want it run. Frankly, I'm surprised that anyone ever agrees to one of these since most of the time I'm arguing from a much stronger position. At any rate, I'd spent way too much time writing my portion of it to not use it at all, so I've modified it into a Q & A post. Hopefully it still works.]
Q.
Why can't I just buy the same stocks that Warren Buffett buys and then enjoy his outsized returns? I mean, there are a few talented managers out there, most of them value stock pickers a la Buffett and he basically gives the instructions in all of his letters to shareholders.
A.
Buying individual stocks is still dumb even if you buy the same ones as Warren Buffett. I love reading Warren Buffett's letters. I also enjoyed reading The Intelligent Investor by Benjamin Graham. I think both are worth reading even if you never buy an individual stock. Let me begin my discussion of purchasing individual stocks with a quotation from each of these fine investors.
“Warren Buffett KU Visit” by Mark Hirschey
What Does Buffett Say You Should Do?
First, Warren Buffett:
A low-cost index fund is the most sensible equity investment for the great majority of investors. My mentor, Ben Graham, took this position many years ago, and everything I have seen since convinces me of its truth.
Then, Benjamin Graham:
I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity, say, 40 years ago, when our textbook “Graham and Dodd” was first published; but the situation has changed a great deal since then. In the old days any well-trained security analyst could do a good professional job of selecting undervalued issues through detailed studies; but in the light of the enormous amount of research now being carried on, I doubt whether in most cases such extensive efforts will generate sufficiently superior selections to justify their cost. To that very limited extent I'm on the side of the “efficient market” school of thought now generally accepted by the professors…
If we could assume that the price of each of the leading issues already reflects the expectable developments of the next year or two, then a random selection should work out as well as one confined to those with the best near-term outlook.
There's point # 1. Both Warren Buffett and Benjamin Graham don't think buying individual stocks is a very good idea. When asked how an investor should invest, they essentially recommend index funds.
Just Buy Berkshire Hathaway
Besides, if you're just going to buy the same stocks as Warren Buffett, there is a far easier way to do so- just buy shares of Berkshire Hathaway (the insurance company shell Warren uses to buy and sell stocks.) Not only does this have the advantage of not having to pick and choose and analyze individual stocks yourself, but you don't even have to wait for his letter to come out at the end of the year. When you own Berkshire Hathaway, you essentially purchase stocks at the same time Warren Buffett does, BECAUSE HE'S BUYING THEM FOR YOU! Plus, don't discount the value of your time. Analyzing stocks, even if you're just reading the annual reports of 5 or 10 gurus and placing a few trades, takes time. You know what your time is worth, so be sure to subtract that from your investment returns! That's point # 2.
Berkshire Hathaway Owns More Than 5 Stocks
Some people think that buying just 5 stocks is somehow a good idea. If it was such a good idea, you would think Warren Buffett, the great investor, would do that with his Berkshire Hathaway money. How money stocks does Berkshire Hathaway own anyway? As of the time of this writing, the total is 45 stocks. Why would you own only 5 if Buffett thinks holding 45 is a good idea? Point # 3.
Uncompensated Risk
I've written before about the concept of uncompensated risk. That's risk for which you aren't paid. If you can diversify away a risk, the market isn't going to pay you to take it. Single stock risk is very diversifiable. So the market isn't going to pay you, on average, to take it. You're not investing. You're gambling. Single stocks can and do go out of business all the time. Remember Enron? What about Worldcom? Delorean? Eastern Airlines? RCA? Pets.com? Compaq? General Foods? Standard Oil? PanAm? Montgomery Ward? American Motors? Woolworth?
Even entire industries go out of business from time to time. How many buggy whip manufacturers do you know of? How many of the original Dow 12 companies still exist in its original form? Only 1. (Although to be fair, the successors of many of the others still exist.) 414 of the original S&P 500 are no longer in that index either. Where'd they go? What happens to your portfolio returns when you only have 5 companies and due to simple bad luck 1 or 2 of them disappear? Single stock risk is real. Point # 4.
Has Buffett Lost His Touch?
Warren Buffett's goal is to beat the S&P 500. Well, he's losing over the last 5 years. He's still got a great record, of course, but it's not perfect by any means. A significant percentage of the great returns he has enjoyed came before many investors were ever born, much less started investing. At any rate, even if he hasn't lost his touch, the dude is 84 years old. How long is your investing horizon? I bet it's longer than Warren Buffett's life expectancy. Then you'll need a new guru. I have met lots of 84 year olds and looked at a lot of 84 year old brains on CT. Even if Warren hasn't yet lost his touch, I'm confident he will soon. When you're 90, your brain just doesn't work the same as when you were 40. Experience can only take you so far. But he failed to mention Point # 5.
It Doesn't Matter What You Do With 2% Of Your Portfolio
If you want to go pick individual stocks, or buy whole life insurance, or dink around with peer to peer loans, or simply put it in a jar and bury it in the backyard, it just doesn't matter what you do with tiny portions of your portfolio. If you think this concentrated portfolio is an awesome idea, then do it with the big money- the 90-98% of your portfolio that is actually going to determine whether you eat Alpo or Caviar in retirement. Nobody cares what you do with your fun money. But the fact is that even proponents of concentrated portfolios still diversify. Why? To protect themselves against the fact that their crystal ball is just as cloudy as the rest of ours. Point # 6.
Picking Talented Managers is a Fool's Errand
Some people suggest that there are a number of Warren Buffetts out there. However, statistically, by the time you are sure that a manager is skillful, and not lucky, he's retired and its too late to jump on the bandwagon. So that leaves you with two options- follow a guru when you're not sure if he's lucky or good, or ignore the guru completely and just buy all the stocks. I know what Warren Buffett would recommend you do. Point # 7.
What About Buffett's Anti-Diversification Advice and Practices?
Some might argue that Warren Buffett has told people to avoid real diversification, such as in this quote from the 1993 letter:
“If you are able to find five to ten sensibly-priced companies that possess important long-term competitive advantages, conventional diversification makes no sense for you. It is apt simply to hurt your results and increase your risk. I cannot understand why an investor of that sort elects to put money into a business that is his 20th favorite rather than simply adding that money to his top choices.”
They might also argue that 70 percent of Berkshire's money is in just 4 stocks, which is true. However, it is important to note that there are far worse ways to invest than this particular method. In fact, if there were no low-cost index mutual funds available, or if the data on the folly of trying to best the “know-nothing” technique of just buying everything were not so robust, I would also likely use a Warren Buffett-like value investing technique to try to select great companies with a wide moat trading at reasonable prices. But there are low-cost index funds, and the data is quite clear about the likelihood of you (or Warren Buffett, or any of his favorite managers) picking winning stocks well enough to overcome the costs, fees, taxes, and time required to do so, especially over the long run.
However, I absolutely agree with Warren that if you're going to be a believer in active management, concentrating your bets in your best ideas is your best chance at beating the market. Hope your best idea isn't Enron.
Warren Buffett Is Not Just A Stockpicker
One other point that ought to be made, is that Warren Buffett isn't just a stockpicker. The old mantra is put all your eggs in one basket AND WATCH THAT BASKET CLOSELY. Warren does that by putting himself onto the boards of the companies he buys. In effect, he's not just buying the stock, he's running the company. He's adding value using his business and managerial skill. While you can buy the stocks Warren buys, when you buy a handful of individual stocks, you're not being put on the boards of the companies yourself. And Warren isn't going to be on those boards for long. Better hope his replacement is as good as he is. Point # 8.
Warren vs The World
While there is no doubt Warren is a savvy businessman and perhaps the world's greatest investor, I prefer to cast my lot with the rest of the world when it comes down to the question of Warren vs the world. How do I side with the world? I simply take the world's estimate of what companies are worth and buy them all at that price while minimizing my transaction and tax costs and eliminating manager risk, stock timing risk etc. When those companies make money, so do I. Warren Buffett owns no publicly traded companies that I don't own myself. If Warren's selected companies do great, that's wonderful. I own them too.
What do you think? Do you think buying a handful of stocks similar to those picked by a guru such as Warren Buffett is appropriate for all or part of your portfolio? Why or why not? Comment below!
Your comment about elder brains resonates strongly with me. This includes the elder brains of financial advisers, my own, Warren’s ,
I stopped with individual stocks for one main reason-my time. When I took it into account I was not beating my benchmark by enough. I want to use our money to make time not take time.
I have moved away from even playing with play money. One reason was since play money was only 10% of the portfolio it was not adding a lot even if I made it big. Another reason was even if I go long like buying a stock for 2 to 10 years, what do I do when it comes time to sell. I dont want capital gains in 2 to 10 years, I am still working for another 20 years.
Now I use my play money to invest in mutual index funds (Vanguard total stock and total international) whenever the market has a correction. For e.g I put in 30K when the markets were down recently. This helps my sleep too.
WCI I think you are also giving SP500 an unfair advantage by comparing only for 5 years. If you look at 10 year chart, BRK.A beats SPY by a big margin.
I have a decent chunk (10% of my portfolio) in berkshire. It was invested some time ago. I am no longer contributing, but have decent gains since I have held it for awhile, I am also in a top tax bracket. Would you guys recommend holding or slowly converting to index funds, and would you count it as a “large value” category?
How long before you retire and need the money? How does the rest of your 90% portfolio look like?
Is it in a taxable account? What is the gain? If it is taxable and a huge gain and you’re 85, I certainly wouldn’t sell it at all. If it is in a Roth IRA, I’d exchange the whole thing today for an index fund. There are far worse individual stock holdings, but that is still what it is. That said, no sense in paying unnecessary taxes.
Thank you, and yeah sorry for lack of details, in my 30s, taxable account. I’m thinking just let it ride since I don’t want to pay taxes. As far as categorizing it for asset allocation would you consider it a large value asset class?
Its a conglomerate.
I probably would not sell it. If you’re no longer investing into it, depending on your age of course it should naturally become less of your overall portfolio, unless of course it just does amazing, typical win win situation. Its a good taxable account stock.
There is also the real possibility given the age of Munger and Buffet, and the nature of the company that it may have a spinoff or special dividend of unseen proportions. Some thing that the only reason BRK is allowed to be the gigantic beast it is is due to the carefully crafted image and general niceness appearance of Buffet and it may even be forced to break up. When people look at it as a collection of stocks, and conctrated, they are overlooking the vast number of hugely diversified businesses that are owned outright. Its more diversified than at first glance.
I thought that I was done buying individual stocks, but one of the attorneys at work mentioned his wife’s father had given her some Gilead Sciences shares and it was doing well. Before he could return from walking to McDonald’s, I had bought some Gilead Sciences shares. I had not purchased any new companies in 5 years. I do own Berkshire Hathaway Class B shares and continue to add to it. But the bulk of our portfolio is in index funds.
Man, you make stock picking sound like an addiction.
Did you do some research on the company before buying? I hold GILD too… I buy or add to individual stocks for the long term when the market overreacts to news. Many such great opportunities come for solid companies when the sector or the market tanks. I’m more of the dividend growth investor type. I hold 30 stocks in varying wieghtages and this has been working for me for years. My wife’s 403 (b) & ORP are in index funds and one mutual fund and this is around 20% of our portfolio. The rest are all stocks I’ve bought after checking their financials, business environment and growth prospects.
I checked the financials, did brief web research and used the overview that my co-worker had given me.
sorry, for some reason my post to Tina got duplicated
Did you do some research on the company before buying? I hold GILD too… I buy or add to individual stocks for the long term when the market overreacts to news. Many such great opportunities come for solid companies when the sector or the market tanks. I’m more of the dividend growth investor type. I hold 30 stocks in varying wieghtages and this has been working for me for years. My wife’s 403 (b) & ORP are in index funds and one mutual fund and this is around 20% of our portfolio. The rest are all stocks I’ve bought after checking their financials, business environment and growth prospects.
I don’t recommend selling if you will have to pay taxes. Given that it is a diversified conglomerate a 10% holding isn’t unreasonable. Save over time and don’t add to Berkshire and it will decline as a percentage of your portfolio.
I think the growth/value dichotomy is largely nonsense and if you actually look at funds’ holdings it’s obvious the managers agree. Consider Berkshire to be something along lines of a large cap mutual fund since it has diversified stock holdings and owned businesses. But – and this is a big but – there is a lot of idiosyncratic risk because it is still an individual stock. What will be the quality of management after Buffett, for example? And after the railroad purchase the stock is probably going to be more cyclical in the past. You’ll have to review things from time to time, at least while it’s a big enough holding to matter.
Sorry my comment was meant to reply to SJ above.
WCI, any thoughts on this?
http://www.marketwatch.com/story/john-bogle-says-you-wont-make-much-money-from-stocks-2015-11-05
Please forgive me for jumping in, but have you seen this? http://www.businessinsider.com/dow-jones-idiot-maker-rally-2013-3
Nobody knows the future, not even Jack Bogle. His crystal ball is just as cloudy as anyone’s. If his prediction of P/E compression is right, and the dividend yield and earnings growth are right, then his prediction in the article, 4% returns over the next decade, will probably be right. But there are a lot of variables there. Plus, as P/E compresses, the outlook for future returns gets better. So yes, we may see 4% in the next decades, then 12% the decade after that! That would be a wonderful circumstance for me as I am a net buyer, not a net seller, of stocks, especially over the next decade. As Bernstein says, young accumulators should get down on their knees and pray for a bear market. Also, bear in mind that it won’t be 4% every year. There will still be great years and very poor years. By periodically investing (what most people wrongly call DCAing) you will end up with more shares than you otherwise would if it were 4% every year.
And rebalance!
Good call. What is the correct definition of DCAing to you versus what people think it means?
You can’t DCA unless lump sum is an option.
Lump sum: Someone hands you $100K and you invest it all at once in the market.
DCA: Someone hands you $100K and you invest it $10K at a time over 10 months because you’re chicken that you might lose money and you use this as a psychological crutch to overcome your anxiety.
Periodic investing: You have $10K extra left over every month after paying your expenses. So you invest it in the market every month. Lump sum isn’t an option because you never had a lump sum.
Yes, exactly! Its presented as if its a choice between taking the 3 million you have today and dumping it in, or averaging it. Unless you’re exceeding unlucky (lottery winning level) you’re unlikely to ever hit an all time high or low anyway. I just cannot seem to find that 3 mil anywhere, so I’ll continue my periodic investing i guess.
Have read articles that the only chance to beat the markets is with a concentrated portfolio
As you reach hundreds of stocks you just will get the average return
As said indexing has proven t be the best method
“Single stocks can and do go out of business all the time. Remember Enron? What about Worldcom? Delorean? Eastern Airlines? RCA? Pets.com? Compaq? General Foods? Standard Oil? PanAm? Montgomery Ward? American Motors? Woolworth?”
I do. I also know that the majority of those companies are still around. Eastern Air is now part of United Airlines. RCA became part of General Electric. Compaq is now Hewlett-Packard. General Foods is Kraft/Mondelez. Standard Oil calls itself a variety of names today, including ExxonMobil, Chevron, and BP (I honestly have no idea why you would list Standard Oil – it was broken up because it was a very successful monopoly, much like the old AT&T). Most of PanAm was acquired by Delta. Montgomery Ward was taken private. American Motor Company is today under the Chrysler umbrella. Woolworth is more commonly known today as Foot Locker.
So even when you were actively trying to list companies that failed miserably, the overwhelming majority of your list is still around.
Excellent point, but surely you’re not suggesting that the main premise, that “single stocks can and do go out of business all the time” is wrong, are you?
I think it’s somewhat misleading. Individual companies absolutely can (and do) go out of business – but it’s not something that happens “all the time.” Most failures tend to result in acquisitions.
Look at the worst of the financial crisis of 2008/2009. It shocked the market that Lehman Bros. would die completely. Horribly run companies like Countrywide were acquired on surprisingly generous terms, and their shareholders made out much better than they realistically should have.
I certainly understand where you’re coming from, but I think it’s probably a bit hyperbolic.
You’re right, it probably is.
I don’t know if researching and picking stocks (or hiring a manager to do that for me) is better or worse than buying a low cost index fund. But I do know myself and my personality, and I would not like researching and picking stocks. I don’t find it enjoyable or thrilling. I like not having to think about it, and I like not having to pay someone else to think about it. To all of you stock-pickers and fund-manager-hirers above: I hope you beat the markets and become billionaires. I’m going to stick with simple, cheap index funds and get on with my life.
The only major downside to low cost index funds is that you can’t have a better return than the entire market. I’m comfortable with that.
There are a few more reasons. First, if you own a total market index fund, Berkshire is the 6th largest holding, and probably represents over 1% of the value of that fund already. Second, if try to copy what Buffet has done, you will already be behind the curve, as he has already run up the value of those stocks, and along with you, the rest of the world also already knows his picks. Third, he is probably already too big to significantly outperform the market. In any case, in addition to buying Berkshire Hathaway yourself, I believe there’s at least one fund that shadows his, but it will have the same weaknesses cited already.
As for Scott’s post above, Eastern Airlines was dissolved in bankruptcy before some of its assets were acquired. Ditto for Pan Am. Compaq is indeed part of Hewlett-Packard, which has disintegrated into 4 companies and whose combined stock price is a fraction of what it was. Woolworth is indeed now Foot Locker. I don’t have data on its market value, but I suspect it’s a lot lower than it was when it was Woolworths. Montgomery Ward went bankrupt in 2001. Several of the others are definitely alive and well, eg Standard Oil, RCA, General Foods, but I don’t have time to research the rest.
Berkshire Hathaway is the number 7 holding in VTSMX, for 1.2% of the fund.
It’s # 7 for Fidelity (FSTVX). Perhaps one of those websites is more up to date than the other.
Most indexers are actually unaware of how concentrated any market weighted index fund really is, and of some of the recent changes to index funds that will diminish some future returns. Idk exact values today, but about $4/100 goes to Apple, and a large proportion of your money is in the top 15-25 stocks, the bottom half are so small they dont really contribute much at all. On the other hand most stockpickers will have basically recreated an index and its returns around 18-20 diversified stocks (sector, etc…). Its actually hard not to be a little bit of both unless you tilt or overweight certain sectors purposefully.
I’ve heard the site Motif will let you basically recreate indexes with whatever their “motifs” are, assuming this gets you the index without the ER. A bunch of buys all for the same price, seems like an interesting concept. I’ll have to look into it.
I have a portfolio of 75 stocks (all dividend payers over 3%, mostly dividend aristocrats) that I have had for the last 12 yrs. It has a yield on cost of 10% as a result of dividend growth. I very seldom ever sell UNLESS the dividend is cut or frozen.
My aim is to produce a stream of dividend income – I am not in it for the capital gains although research and personnel experience has shown that such dividend paying stocks outperform the s&p. I am letting the magic of compounding work for me! Although it was painful in 2009 (30%) down, I let it ride since my dividends were still being maintained and actually increasing.
I hope that such dividend income will pay for my monthly bill when I retire!!!
Why would yield on cost be a useful measure? If you like that 10% figure now, wait until 30 years from now!
Only spending the dividends is a good way to work far longer than you need to.
More than 1 out of 5 S&P 500 companies cut their dividend in 2008 or 2009. I’m impressed you are a good enough stock picker that your dividends actually went up in that time period.
Yield on cost is a psychological metric, and can be good for showing you the power of compounding, staying the course, and patience but otherwise its a “non-gaap” type metric that leads people astray. I’ve heard them preach how they may never sell due to this YOC while they could easily buy more than their actual yield elsewhere, same risk level. Its nice, but not real, sunk cost fallacy and all.
Right, but by swapping from one portfolio to another, both performing exactly the same, you’ve reduced your yield on cost. It’s just not a metric that matters. It’s like a fun fact, but not terribly relevant.
If you follow a plan, tune out the market gyrations and concentrate on the dividends (and by that I mean companies that are RAISING their dividends yearly and consistently), you will be successful. I follow David Fish’s data monthly to find such companies. I re-invest every dividend paid at this point. Only when I retire will I live off the actual dividend.
Will this strategy beat the S&P 500? May or may not. But that is not my goal. My goal is to provide an increasing, reliable stream of income from the portfolio. I think most people get into trouble with individual stocks because they get too emotional over the daily gyrations of the market. They are out for the one stock to make them a fortune! This clearly will not work
While I agree gambling on one stock will not work, concentrate on dividends isn’t a particularly genius method. If you’re not beating the S&P 500, there is a very easy way to match it, guaranteed….
But over the last 50 yrs, dividend paying stocks have beat the S&P- that is Total Return!!
“showing you the power of compounding, staying the course, and patience”
This is the secret to being successful with individual stocks – not many people are able to do this with all of the “noise” from CNBC, Market Watch etc…..
I knew I would have a lot of negative comments for my strategy, but it has been working for me so far and a lot of others – i.e Dividend Mantra – http://www.dividendmantra.com/ -Maybe reading a little of his posts may make the strategy more clear.
The big problem in the DGI universe is the same problem that has plagued all strategies now that the information is at everyones fingertips instantly, it becomes a meme almost, with tribal groups going into growth, spec, income, or dgi (lots of flavors). Couple this with a growth boom and bust of epic proportions (tech bubble) and the great recession in 2008 it has has left a deep psychological scar on this era of investors. Enter stage left DGI, good long standing stocks (some well over a 100 years old) with long histories of dividends and increases doing great through all world wars, depressions, recessions, etc…you name it. Now, this is pretty much true for several companies (viewed through the retrospectoscope of course), but alas this is not the problem.
The psychological scar and stability/income match was too good and was/is just a right fit for after such a trauma, however, it is now one of the most crowded trades ever. The whole reason these companies performed so amazingly in the last 20 years is because they were boring, stupid boring and slow growing, not amazon, google, apple or microsoft. They have low PEs, decent dividends, etc…now its such a movement that (well, more true earlier in the year) these things are not true anymore. The PEs are not what you’d expect from a terminal growth company, and the dividends are low (outside energy). Plus, with these crazy rules of thumb like sell when a company smartly freezes or reduces an unsustainable dividend to increase free cash flow to survive, you have a self fulfilling prophecy of capital destruction that divs will not make up for.
I dont care how many time DGI folks say “income”, i get it, and like dividends as much as the next guy, but total return is the only thing that matters, money is fungible. I can turn around and buy dividends whenever I change my mind. Selling shares is no different than collecting a dividend in the end (the money goes to growth of eps/increase share price or you), if you start with enough you’ll still not be able to draw it all the way down and it will continue to grow. I do get the concept, and have dividend payers myself, Im just not religious about it.
A dividend strategy (only spending divs, never selling) only works if you start with enough or let it compound for 50 years, which if either of those things were true, any other strategy would also work, its a tautology. I dont care what youre strategy is, if you only have 10k of principal when you retire but have 50k of bills, divs aint cutting it, and neither will selling.
Amen. If you only spend the dividends you should expect to die with several times what you retired with. Think of it this way. Let’s say you put together a portfolio of stocks with a dividend of 2.5% and a total annualized return of 7.5%. You get to spend 2.5% a year and the portfolio grows at 5% a year. So if your retirement is 30 years long, you die with 4.3X what you retired with. Personally, I’d rather spend 4% of the portfolio and die with (on average) 2.8X what I retired with.
You just don’t get it…..
The dividend is growing each year – it does not stay constant like a bond
We can argue all we want over different strategies.
My point is that indexing is not the “end all be all” to investing.
I get it just fine. But there is nothing magical about a dividend. I can declare a Berkshire Hathaway dividend any time I want, sell a few shares, and Voila- I’ve got income.
When you boil it down, it’s just a value investing strategy. Which is fine. I LIKE value investing strategies. But I don’t pretend there is anything magical about it. For example, consider GM. A fantastic dividend stock. Paid reliable, consistent dividends for years. Then, 10 years ago in 2005, the dividend yield went over 10%. 10%! Awesome! Except then the dividend was cut from 50 cents a share to 25 cents a share in 2006. Then in 2008, it wasn’t paid at all. Then in 2009 it went bankrupt. The list goes on- J.C.Penny, Kodak, Radioshack, Barnes and Noble, Books a Million, Washington Mutual, The McClatchy Company, Citigroup, RiteAid, Bank of America, BP, AIG, Ford etc etc etc.
So, I agree. Dividends DON’T stay constant like a bond. Sometimes they go up. And sometimes they go down. And sometimes they go away all together. Stocks aren’t bonds. Dividends aren’t coupons.
If you save enough, just about any strategy works fine.
“If you save enough, just about any strategy works fine.”
I must have missed this part in your article 🙂
Yes, just save 60% of your income and you can even retire on whole life insurance.
https://www.whitecoatinvestor.com/the-reason-you-take-market-risk/
But I think it’s worth looking for the best strategy too, which allows you to save less, retire sooner, and/or spend more in retirement.
>>Let’s say you put together a portfolio of stocks with a dividend of 2.5% and a total annualized return of 7.5%. You get to spend 2.5% a year and the portfolio grows at 5% a year. So if your retirement is 30 years long, you die with 4.3X what you retired with. Personally, I’d rather spend 4% of the portfolio and die with (on average) 2.8X what I retired with.
The forecast isn’t that simple. Dividend growth stocks are owned for the expectation of growing dividends as the name suggests. And the new safe withdrawal rate for retirement has been changed from 4% to 2% due to increased life expectancy and low bond yields. The 4% withdraweral rate was made at a time with the expectation of a higher tilt towards bonds in retirement and these safe bonds had a descent yield.
I expect dividends to keep up with inflation on average over the long run. So a 2.5% dividend will be the same in 30 years on an real basis. I accounted for that.
A 4% withdrawal rate survived the Great Depression, WWII, Stagflation of the 70s, the internet boom and bust, the Great Recession and everything in between. You must have some super secret data to suggest that 4% is now 2%. That’s stupid. I can buy 30 year TIPS paying 0% and have a 3.33% withdrawal rate. But 30 year TIPS are currently paying 1.20%. So without using stocks or real estate at all, your 30 year SWR can be higher than 3.33%.
But if you want to spend 2% of your portfolio, that’s your right. Please include me in your will. 🙂
>>I expect dividends to keep up with inflation on average over the long run. So a 2.5% dividend will be the same in 30 years on an real basis. I accounted for that.
That is your expectation but dividend growth investors look for companies that grow dividends anywhere from 5% annually to a lot more.
>>A 4% withdrawal rate survived the Great Depression, WWII, Stagflation of the 70s, the internet boom and bust, the Great Recession and everything in between.
The 4% rule was developed in the 90s. Your assumptions are based on studies that used interest rates in the 80s when they were far higher and issues from the 80s carried over into the 90s and early 2000s. The 4% withdrawal rule in retirement was made with the instruction to retirees to move to higher allocation in bonds (50%) which provided the safety and income part of a portfolio. In 1981, the 2 yr, 5 yr and 10 year were all between 15% and 16% averaging around 6% between 1981 and 2012 . In 2012, the 2 yr, 5 yr and 10 yr were in the ranges of 0.16%, 0.56% and 1.43%. The 4% withdrawal rule no longer applies if it is based on those studies.
>> You must have some super secret data to suggest that 4% is now 2%. That’s stupid.
Actually it’s not a secret. It’s been out there for quite sometime. There are many studies revising the 4% safe withdrawal rate in light of lower bond yields. You sound surprised so you are probably not aware of it.
http://time.com/money/2795168/forget-the-4-withdrawal-rule/
http://www.wsj.com/articles/SB10001424127887324162304578304491492559684
http://www.mymoneydesign.com/personal-finance-2/retirement/is-2-percent-the-new-safe-retirement-withdrawal-rate/
Oh, I’ve seen the studies. I’ve read them. I don’t believe their conclusion to start with, but to end with, I don’t care about their conclusion because I don’t intend to use some kind of blind withdrawal rate as my basis for spending down my assets. I intend to adjust as I go.
If you genuinely only expect 3% returns on your portfolio going forward, there’s no sense in investing in stocks and bonds at all. Go buy some real estate. There’s plenty of Cap Rate 6 real estate out there that will give you a 6% return without any appreciation at all. And that’s unleveraged. Heck, you can get 2% guaranteed out of whole life insurance. 30 year TIPS will give you 1.2% real. If you’re so paranoid you’ll run out of money that you’re only going to spend 2% of your stash a year, buy a SPIA for crying out loud.
But like I said, if you want to start out spending 2% of your retirement stash, be my guest. No skin off my nose. Seriously, it doesn’t bother me one bit. But you ought to think about what that means in terms of how you invest.
By the way, those aren’t studies you linked to. Those are articles written by journalists about the studies. Read the studies, especially the assumptions, and decide if you agree with the conclusions.
>>By the way, those aren’t studies you linked to. Those are articles written by journalists about the studies. Read the studies, especially the assumptions, and decide if you agree with the conclusions.
I read the studies a long time ago when they first came out. They factor in current bond yields which were a large part of the basis of the 4% withdrawal rate back when it was determined in the 90s and used bond yields that were far higher than anything today. You said that the new studies were some sort of “secret” so I just did a quick google search and gave you the initial results. It’s not a “secret”. It’s been out there for a long time.
What I’m saying is I’ve read the studies and I don’t agree with the conclusions because I don’t agree with the assumptions. So you must have some other secret data that convinces you they’re actually right. Or maybe you think stock investors are going to accept 4% returns when they drive by investments paying 6% real every day on their way to work. Which I don’t buy.
And I’m saying I don’t care because I don’t plan to follow any blind withdrawal rule, whether it is a 4% rule or a 2.5% rule. I plan to buy SPIAs to put a floor under spending and then adjust the rest as I go.
The trinity study, where the 4% came from did not advocate for high bond allocations. This is what everyone seems to miss about the study. His conclusion was that a final allocation should be 75/25 stocks/bonds. That would be seen as aggressive today, but shouldnt be as it gives you better risk adjusted returns and nearly the same return as 100% stocks.
It has always been the case that the more bonds you have in a portfolio, the more stable it is, but the faster the portfolio will go to zero. For longevity, its stocks, the bonds are there so you can sleep.
Here you go: http://poseidon01.ssrn.com/delivery.php?ID=570005095083086097007000096074018104100051081067090053088027112105127016070073080070039012044061104010048120011121097094093121019053041013058003001009000094068031020022037104118082121073098020123096016022097091094118004116074084064087113104106004121&EXT=pdf
Read the assumptions and see if you agree. I’ll give you a hint. Pfau assumes portfolio returns of 4% lower than average historical returns. If you truly believe that is what you are going to see over your investment horizon, I would suggest investing in something besides stocks and bonds. But you’ve got to ask yourself why an investor is going to invest in stocks at a 2% or 3% real return when he can go buy properties paying a real return of 6%+. Or why he will invest in a portfolio of stocks and bonds with an expected 0% or 1% return when he can get a guaranteed 0% return on a whole life policy. Or why an investor is going to use a 2% or 2.5% withdrawal rate when he could have just bought a ladder of 30 year TIPS and had a 3.5%+ return, guaranteed. Stare at it long enough and you’ll see why it doesn’t make sense, and even if it does, it doesn’t matter anyway.
When you get to retirement, buy a SPIA to cover your minimal spending needs, and adjust the rest as you go.
>>if you only have 10k of principal when you retire but have 50k of bills, divs aint cutting it, and neither will selling.
This is not an argument against dividend growth investing…this is an argument for saving.
>>”The big problem in the DGI universe is the same problem that has plagued all strategies now that the information is at everyones fingertips instantly, it becomes a meme almost, with tribal groups going into growth, spec, income, or dgi (lots of flavors). Couple this with a growth boom and bust of epic proportions (tech bubble) and the great recession in 2008 it has has left a deep psychological scar on this era of investors.”
Replace DGI with low cost index funds/etfs and the same observations apply.
It’s not a new strategy. People have been doing it for a long time. It gives your portfolio a slight value tilt which should beat the market over the long haul due to the increased risk. But it turns out there are better ways to get that tilt.
That said, if you save enough money, this strategy will work just fine.
Very interesting article. Warren Buffett’s “mutual fund” (Berkshire Hathaway) has always intrigued me, I guess because I don’t know enough about his beginnings in the investing world and by what percentage his holdings have changed over time. In addition to the points mentioned by WCI, another point against following Warren Buffett: considering the fact that Mr. Buffett is of an older age, wouldn’t that mean that he’s potentially moved on to less risky investments that have the potential to create a continuous flow of income instead of focusing on high growth investments? If that’s the case, I think it would be unwise for a young investor with a long investing time frame to buy into Berkshire Hathaway since Warren’s portfolio would likely be more conservative than risky.
Rex- not sure what you know of Buffett, but it sounds like you’re saying he may have transitioned to an income producing strategy vs a growth strategy. With tens of billions in net worth, he doesn’t need a dime of dividends, and from what I gather he’s as focused as ever on finding what he considers to be undervalued assets for the future growth, not for any factor related to income. As a matter of fact, his own fund famously does not issue dividends…
Frankly, there are just some stocks that I like so I own them outright. Some have gone on “sale” and I purchased a bit more if I could. I also use ETFs. For me it will be fun to see how overtime the strategies end up comparing.
cd :O)
Very interesting and lively discussion here. Just thought I’d give a thumbs up to WCI. I’ve been reading a bunch of the Pfau material and have come to the conclusion that he’s down on the 4% rule because… drumroll please… he’s selling annuities.
Doesn’t take long to see through the smoke & I’m no expert.
Glad other people agree. I stopped reading last year because I just couldnt get past the strange assumptions and blanket statements on what will and wont work. I realize he’s writing for say, everyone, but as we’ve discussed here, if you save enough any strategy will work, even a mattress. So I just couldnt do it any longer. To compare past/present and only take into effect a negative (slower growth, possibly, dont buy it personally) on one side without the positive on the other (low inflation) is disingenuous.
Really we’re dealing with a lot of demographic issues. Lots of boomers selling to a smaller X generation will probably subdue returns for awhile, but maybe international growth can help this some. Millenials arent investing yet, but around 2025ish they will come into their peak years and start as well, giving the smaller X generation the largest net buyers we’ve ever seen. Im totally fine with low/no growth for a decade or so of accumulation to have assets increase nicely afterwards. Theres a great chart of market value and birth rate +45 years that demonstrates a wild correlation. Not causation of course, but definitely food for thought.
Another good reason to own Berkshire stock is to take advantage of shareholder weekend deals… granted, you either have to live in / go to Omaha or phone your order in / take delivery from a local outlet for the participating store, but for those geographically fortunate people it’s a great deal.
I have seen a few articles quoting a study which showed that if you buy the stocks that BRK bought (when the info is public), you will outperform the market and maybe even BRK (as a whole). Are they flawed studies? Here is one:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=806246
I don’t know if they’re flawed, but they using back-tested data. Where are the other Warren Buffetts and how can you identify them in advance? And will using this strategy in the future beat the market? Those are the issues.