How does the stache grows without reinvestment of dividens/capital gains?

[bigote2032]

Hello Mustachians!

I have a stupid question.  In the Trinity Study, in most of the success cases we end up with a much larger stache than it was in first FIRE day.  However, I don't understand how the stache (say a pure index fund stache) will actually grow at all if we set the fund to send us a check for dividens, capital gain/interest.

What am I missing?  I really hope I am missing something, otherwise my FIRE plans are doomed.

Thanks in advance for your help & support.

Bigote2032

[sokoloff]

You have three types of gains in a typical index fund: dividend payments, realized/distributed capital gains, and unrealized capital gains. Even if you get and cash the checks for the first two, the share price of the fund (typically) grows.

That’s not near as fast growth as if you directed all the various gains back into the fund, obviously, but it can still grow.

[Eric]

In the most basic terms, the Safe Withdrawal Rate is 4% versus a long term stock market (real) return of 7%.

[bigote2032]

Ok, let see if I understand.

Unrealize gains are "on paper", I won't get them until I sell the stock that appreciated.
Realized gains are "realized" when I sell the stock that appreciated and only then I can have my gains (and deal with tax implications).

Fidelity has a the option to send you a check for capital gains, it does not say if they are realized or unrealized.  Please help me understand, if I sell index fund stock, say one share with a basis of $10 and at the moment of selling, it is worth $15.  The $5 bucks will be deposited via that Fidelity option I chose? Asking because I am in accumulation phase and have never used that option.  If my assumption is correct, I will never get any checks for capital gains if I don't sell any stock that appreciated?

Thanks Eric and Sokoloff for your responses, very kind of you.

[DreamFIRE]

They are referring to the reinvestment of dividends and capital gains distributions, NOT capital gains from you selling shares of the fund.

https://www.fidelity.com/customer-service/how-to-dividend-and-cap-gains-distributions

[bigote2032]

You lost me there Dream

"you might receive distributions from these investments in the form of dividends and/or capital gains"

Let me take a guess, so you are saying that I will get capital gains directly from the fund just the same way I get dividends?  Why would they do that? And why they don't let those gains be realized with the other gains  when you sell stock? It seems we don't get to choose.  And what percentage of those gains they will return to you as opposed to the percentage of realized ones?

Thxs.

[DreamFIRE]

They are not the same, so the gains are not realized the same way.  Here is a webpage that explains capital gains distributions and why they are taxable:

https://www.thebalance.com/mutual-fund-capital-gains-distributions-2466692

[MDM]

1. Let me take a guess, so you are saying that I will get capital gains directly from the fund just the same way I get dividends?
2. Why would they do that?
3. And why they don't let those gains be realized with the other gains  when you sell stock?
4. It seems we don't get to choose. 
5. And what percentage of those gains they will return to you as opposed to the percentage of realized ones?

1. Yes.  The dividends appears in box 1 of Form 1099-DIV, while the capital gain distributions appear in box 2.
2. Because mutual funds sometimes get capital gains when they sell some of their stock holdings, and they distribute those capital gains to the fund shareholders.
3. Note the difference between the fund earning capital gains, vs. you earning capital gains when you sell shares of the fund.  Does that make sense?
4. Correct, for the distributed capital gains.  Not correct, for your choice of when to sell fund shares.
5. Varies by fund.

[bigote2032]

Dream, thanks, that article explains it very well, I did not know about these capital gain distributions, so lesson learned.

MDM, thanks for addressing all my questions, all clear and understood now :)

[Laura33]

I don't understand how the stache (say a pure index fund stache) will actually grow at all if we set the fund to send us a check for dividens, capital gain/interest.

You are conflating two different things.  The Trinity Study is based on withdrawing 4% of your portfolio, adjusted for inflation annually.  Since the stock market, on average, tends to do better than 4% + inflation, over time, your portfolio will grow in most scenarios.

What you are focusing on is how you withdraw that 4%.  One way to do that is to have your dividends and annual CGs sent directly to you -- but that number will very likely not end up being 4%.  In most cases, it will be less, because usually dividends are on the order of 1-3%, and realized CGs are much less than that (you just get those when the fund you own buys/sells shares, so it tends to be minimal).  So in most cases, to get to your full 4%, you will need to supplement by selling some of your investments. 

You are correct that, if all of the companies you invested in passed along 100% of their profit every year as dividends and/or CGs, your investments would not grow.  But per the above, most companies/funds do not do that -- they reinvest some of the profits, which increases the value of the business over time.  And even if they did, that would also very likely mean you were withdrawing much more than the 4% used in the Trinity Study --  as mentioned above, the stock market tends to do much more than 4% on average, and that is because most companies turn more than 4% profit every year.  So if a company decided to pass on all of its annual profits to shareholders as dividends, and you had them send that money directly to you, you'd be pulling out way more than 4% in most years. 

It helps keep things straight if you keep a mental line between the amount of money you can take out every year (the 4%/Trinity Study) and how you take out that money (which is where dividends and CGs come into play).