Author Topic: Living off investments: is it really this simple?  (Read 11031 times)

iampatriciag

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Living off investments: is it really this simple?
« on: May 25, 2014, 07:44:34 PM »
Long-time reader, first time commenter: after finally getting all caught up on the MMM blogs and having done a fair bit of reading through the forums, I feel like I've got a pretty good middle-ground understanding of investing.  I've put some spare dollars to work at Vanguard but I need a few gaps filled, like the real basics.  So, even though I feel like a dummy, surely the MMM community will deliver!

Ok, for starters, what exactly are FI/ER folks living off of?  I understand the concept of maxing out the 401k, even if you're not going to access the funds for years, and have benefitted from several dividend payouts from a non-retirement account myself, but once all the accounts together reach the target goal (say $800k or whatever), where does the income tend to come from? Can it be 100% dividends, even the dividends from the 401k?  Or is it partly dividends and partly selling stocks within the SWR from some non-retirement account? 

(A little background: I grew up in Canada, parents never invested, are not funding retirement accounts as far as I know, but I am now living in the U.S., father-in-law enjoys shopping around on the stock market, husband is a little more cautious and only a little more knowledgeable about 401k/IRA/other investment vehicles than I am, so while the MMM site have cleared things up a great deal, my actual understanding still leaves me feeling like a bit of a noob.)


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Re: Living off investments: is it really this simple?
« Reply #1 on: May 25, 2014, 08:08:56 PM »
I am new to MMM/ER/FI but have been investing in my 401k for the last few years. This is my understanding.

-- invest in whatever accounts you have available: either tax advantaged or taxable.
-- when the total is 25 times your desired annual expense then you have achieved FI
-- how to extract the living expenses is a different matter:
-- if taxable it is straightforward: either sell shares or use dividends
-- if tax advantaged then need to take into account how to withdraw while minimizing penalties.


innerscorecard

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Re: Living off investments: is it really this simple?
« Reply #2 on: May 25, 2014, 11:54:59 PM »
Yes, you will have to sell shares.

You need to keep in mind that in reality getting dividends which you don't immediately reinvest is exactly the same as selling shares (even tax-wise, assuming you are selling the shares of long-term holdings).

blueeyetea

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Re: Living off investments: is it really this simple?
« Reply #3 on: May 26, 2014, 12:37:02 PM »
where does the income tend to come from? Can it be 100% dividends, even the dividends from the 401k?  Or is it partly dividends and partly selling stocks within the SWR from some non-retirement account? 

I don't agree you'll have to sell your investment for income.   That's the whole point of saving for retirement, your investments grow until such time that they produce a passive income, which can be dividends or interest.   If you just start selling your investments to use as income, you need an other source of income to make up reduction in dividends and interests, for example paid employment.

I'm in Canada, so I don't know what happens to the 401k once you retire.  If it's anything like RRSPs in Canada, at age 71, they get converted to some type of registered retirement income fund.  Nothing changes to the investments except that you have to start making withdrawals every year instead of making contributions.  The withdrawals can be in cash or in kind, where you withdraw an investment out of the registered fund into a non-registered account.  From that account, you'll continue to receive the income in dividends or interest. 

 

iampatriciag

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Re: Living off investments: is it really this simple?
« Reply #4 on: May 26, 2014, 01:24:52 PM »

You need to keep in mind that in reality getting dividends which you don't immediately reinvest is exactly the same as selling shares

Really?  In what way?  I thought dividends that weren't reinvested didn't really influence the amount of shares one held...


Also,

That's the whole point of saving for retirement, your investments grow until such time that they produce a passive income, which can be dividends or interest.   

I didn't realize investment accounts generated interest, per se.  Or is this the same thing as capital gains?  Or are those something else entirely?


AlanStache

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Re: Living off investments: is it really this simple?
« Reply #5 on: May 26, 2014, 01:32:18 PM »
Dividends are paid to share holders,  I get 0.2$ for ever share of xyz I own, I can automatically reinvest that or take it as a cash payment into my account.  If I take it as cash I have just as many shares after as before, if I reinvest it I get something close to the market rate more shares for the dollars I would have got.  Automatic reinvestment is done without transaction fee (so far as I know). 

The idea of a safe withdrawl rate is that on average the market goes up 7-8% (before inflation) per year and I take out 4% of the total per year, there for there is still 4-3% of a gain and on average my account per year and it will grow even while I am taking from it.

401k: normally 'young' people will not take form this directly they will set up a Roth pipe line, google it.

EDIT: the 7-8% yearly gain includes both dividends and higher market prices.  Some funds/stocks will get more or less from each if they are tracking the larger market.  7% is considered a long term average for the entire market taken together.
« Last Edit: May 26, 2014, 01:45:56 PM by AlanStache »

SDREMNGR

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Re: Living off investments: is it really this simple?
« Reply #6 on: May 26, 2014, 01:33:48 PM »
If you are taking 4% of your stock (for simplicity sake, let's just say stocks) then you can take it as 1) all sale proceeds, 2) all dividends, 3) some combination of both.

If your standard default is to reinvest all dividends then the only part that matters is tax treatment of how you take out your money.  I think it's preferable to sell and take capital gains on it instead of taking straight dividends (this is assuming that you are still in a tax sheltered account).  This is because you can take it from capital gains and be at lower tax rate.  If you are harvesting from a taxable account, it doesn't really matter which since you will be paying taxes on it regardless whether you are reinvesting the dividend or not, you pay income taxes on it anyways.

So if you are harvesting from a tax sheltered account, I'd say selling is preferable to straight dividends because of the tax treatment.  If from a taxable account, it doesn't matter.  But the 4% includes both dividends and stock sales.
« Last Edit: May 26, 2014, 02:27:37 PM by SDREMNGR »

Emilyngh

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Re: Living off investments: is it really this simple?
« Reply #7 on: May 26, 2014, 01:38:23 PM »
That's the whole point of saving for retirement, your investments grow until such time that they produce a passive income, which can be dividends or interest.   


A passive income just means that it's generated by your investments vs employment earnings.   This does not have to be purely dividends, but includes gains.   You buy stocks, their value increases, and then if you sell some, as long as those left are still worth more than you started with, you did not touch your principal.   Eg, I buy 100 shares of a stock for $100, they increase over the years to be worth a total of $200, I can sell half of them for $100, and am still not touching the principal.  ( I personally don't have an issue with slowly spending down principal, but one could sell shares without ever doing so).  This $ is still "passive income" even though it is from selling stocks.

« Last Edit: May 26, 2014, 02:42:48 PM by Emilyngh »

Emilyngh

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Re: Living off investments: is it really this simple?
« Reply #8 on: May 26, 2014, 01:51:35 PM »

Really?  In what way?  I thought dividends that weren't reinvested didn't really influence the amount of shares one held...

Also,

I didn't realize investment accounts generated interest, per se.  Or is this the same thing as capital gains?  Or are those something else entirely?

Not reinvesting dividends influences the number of shares held in that the shares that would have been purchased if dividends were reinvested are not.

And you are correct that stocks don't generate interest.   I'm assuming the poster accidentally used the word interest instead of gains, which I've done before out of the habit of talking about things in terms of interest (eg., compound interest, etc).   Either that, or s/he was ignoring gains entirely and just referring to stock dividends and bond interest.
« Last Edit: May 26, 2014, 02:38:31 PM by Emilyngh »

EscapeVelocity2020

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Re: Living off investments: is it really this simple?
« Reply #9 on: May 26, 2014, 02:33:30 PM »
Hope this helps, to keep it simple a 'traditional retiree' has a target asset allocation (say 60% equities / 40 % bonds) and a required income.  At the beginning of the year, you have an expected income from interest on bonds and dividends from stock.  To make up any shortfall, you either sell equity or bonds to bring your asset allocation back to desired ratio.

If equities gain significantly, you will have years when you sell equities and still may be 'equity heavy'.  In that case, you should sell equities and buy bonds.  Vica versa if equities decline.

There are several variations (especially around tax planning), but learning the basics is a good start.  There was a multi-year real world retiree posting this at one point (thru 2008 meltdown and subsequent recovery) and it really works!  Stinks that the site went DNS a few years ago... I'd love to be able to share it.

Tyler

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Re: Living off investments: is it really this simple?
« Reply #10 on: May 26, 2014, 03:11:58 PM »

You need to keep in mind that in reality getting dividends which you don't immediately reinvest is exactly the same as selling shares

Really?  In what way?  I thought dividends that weren't reinvested didn't really influence the amount of shares one held...


The number of shares doesn't change, but their value does.  When a company pays a dividend, the stock price is adjusted downward by the amount of the dividend.  You have the same number of shares and cash in your pocket, but your net worth is effectively unchanged.  So receiving a 2% dividend on 100 shares of stock will leave you with the same amount of money on the ex-dividend date as selling 2 shares of an equivalent non-dividend stock. 

http://www.investopedia.com/articles/stocks/07/dividend_implications.asp

« Last Edit: May 26, 2014, 03:23:18 PM by Tyler »

innerscorecard

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Re: Living off investments: is it really this simple?
« Reply #11 on: May 26, 2014, 08:15:09 PM »

You need to keep in mind that in reality getting dividends which you don't immediately reinvest is exactly the same as selling shares

Really?  In what way?  I thought dividends that weren't reinvested didn't really influence the amount of shares one held...


The number of shares doesn't change, but their value does.  When a company pays a dividend, the stock price is adjusted downward by the amount of the dividend.  You have the same number of shares and cash in your pocket, but your net worth is effectively unchanged.  So receiving a 2% dividend on 100 shares of stock will leave you with the same amount of money on the ex-dividend date as selling 2 shares of an equivalent non-dividend stock. 

http://www.investopedia.com/articles/stocks/07/dividend_implications.asp

Exactly. I like dividends, as companies that pay them tend to be better companies, but dividends themselves aren't free money. They're taken out of the company and the company's stock price will reflect that.

So many individual investors like dividends because spending dividend money feels better than having to sell off shares. But if you are spending dividend money rather than re-investing it, it is exactly as if you are selling off shares in those securities.

hodedofome

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Re: Living off investments: is it really this simple?
« Reply #12 on: May 27, 2014, 06:25:25 AM »
Unless you have millions of dollars invested you aren't gonna be able to live on dividends alone. Companies prefer to buy back stock these days rather than pay dividends. Therefore the market as a whole pays less dividends than it used to.

AJDZee

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Re: Living off investments: is it really this simple?
« Reply #13 on: May 27, 2014, 07:40:06 AM »
With the SWR you can end any given year with your portfolio balance intact... but if you're living off a combination of selling shares + dividends, with each sale in shares the following year you'll have less shares to receive dividends from, even though the portfolio value is the same. This then starts a year-over-year effect of having fewer and fewer shares paying dividends, so you're mix will change over time. (shift towards capital gains)

If you're savvy enough with your holdings to have companies that consistently increase their dividends this effect will be buffered (at the beginning), but it's something to be aware of.

As time goes on, dividend increases will have a smaller impact on your income as you'll have less shares to receive that dividend and said increase.
Cheers!

iampatriciag

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Re: Living off investments: is it really this simple?
« Reply #14 on: May 27, 2014, 09:15:42 AM »
Very interesting, everyone.  Thanks for the feedback.

It sounds like you have to be careful either way, but then how does one live off investments indefinitely (if you are better off reinvesting dividends and not selling stocks)?

warfreak2

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Re: Living off investments: is it really this simple?
« Reply #15 on: May 27, 2014, 09:29:35 AM »
Very interesting, everyone.  Thanks for the feedback.

It sounds like you have to be careful either way, but then how does one live off investments indefinitely (if you are better off reinvesting dividends and not selling stocks)?
Obviously you're "better off" (in the sense of having more money) if you keep working instead of retiring, but for some reason people like to retire anyway.

matchewed

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Re: Living off investments: is it really this simple?
« Reply #16 on: May 27, 2014, 09:42:01 AM »
Very interesting, everyone.  Thanks for the feedback.

It sounds like you have to be careful either way, but then how does one live off investments indefinitely (if you are better off reinvesting dividends and not selling stocks)?

It seems like we have to dial it back a bit. Rather than talk about the methodology of all the various ways of FIREing it seems you're asking about the foundation. It is rather simple.

a) You are saving a great deal of cash now for your future.

b) That cash will be distributed into some sort of investment (one of the many many methodologies out there) which will generate a return that is greater than or equal to your future withdrawal.

The methodologies could be an infinite list under b). While you're starting focus on minimizing your expenses, saving a large percent of your money, read investment books. We can get a bit tangled here with the details and can easily throw you off the path of knowledge by our own inner squabbles discussions over dividends vs. index funds vs. etc. I'd highly recommend starting out with reading up more on investment especially since you describe yourself as middle-ground knowledge on investing but don't seem to understand how it generates capital and admit you need some basics.

c) Withdraw what you need to live.

The nuts and bolts get rather fractured, but taking your time and understanding them is useful. Taking your time is key. If you start saving now and you're 10ish years from FIRE you will have a good deal of time to understand this better and start recognizing the nuts and bolts.

EscapeVelocity2020

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Re: Living off investments: is it really this simple?
« Reply #17 on: May 27, 2014, 02:28:31 PM »
Very interesting, everyone.  Thanks for the feedback.

It sounds like you have to be careful either way, but then how does one live off investments indefinitely (if you are better off reinvesting dividends and not selling stocks)?

Please have a close look at what I wrote, I'm only re-posting because this is quite important and not discussed very often here.  Bogleheads (the Vanguard investor forum) probably has a good article in their wiki about it.  Many folks are (understandably) focusing on dividends, but equities should be looked at in terms of 'total return' (capital appreciation as well as dividend yield).  Some 'growth stocks' have no dividends, but have a better total return than a blue chip paying a 4% dividend yield but not going up (in value).  This is probably why many folks stick with buying an Index as opposed to individual stocks, it gives you exposure to a blend of growth and yield, but there is no magical difference between a dividend vs. a stock going up in value.  In fact, having capital gains gives you control over when you realize the gain (or loss) vs. a fixed quarterly dividend payout.

As to how investments last in perpetuity, it is exactly as I outlined previously.  If bonds and dividends provide enough income, you never sell anything, so that's straightforward, but unrealistic in today's low yield environment.  A more realistic strategy is living off of yield and selling either bonds or stocks to maintain a stable asset allocation. 

For a concrete example, in a good year like last year, I would also have sold additional stock to buy bonds because equities gained ~30% and I planned to spend 4% of my portfolio value.  To be specific, if I were 60% in equities and had a million dollar portfolio, I could spend 40k, which is provided by a 2% bond yield, 2% dividend yield from equities, and the remaining 2% shortfall covered by equity gains.  That would leave an additional 160k gain in equities (600k equities x 30% gain - 20k income requirement).  The 'safest' way to limit the increased exposure to equities then, is to sell some and buy bonds to bring the investment portfolio, now worth 1.16 million, back to 60/40.  That way, if equities have a down year, you hopefully have sheltered previous gains in an uncorrelated asset class.

I'll have to put a more detailed post about this in my blog at some point, because it really is important to understand, but I hope what I've written gets you started.


wtjbatman

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Re: Living off investments: is it really this simple?
« Reply #18 on: May 27, 2014, 09:36:53 PM »
I'm only re-posting because this is quite important and not discussed very often here.

Someone doesn't read Investor Alley too often. It's only discussed in every other thread.

Fortuna

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Re: Living off investments: is it really this simple?
« Reply #19 on: May 27, 2014, 10:06:51 PM »
where does the income tend to come from? Can it be 100% dividends, even the dividends from the 401k?  Or is it partly dividends and partly selling stocks within the SWR from some non-retirement account? 

I don't agree you'll have to sell your investment for income.   That's the whole point of saving for retirement, your investments grow until such time that they produce a passive income, which can be dividends or interest.   If you just start selling your investments to use as income, you need an other source of income to make up reduction in dividends and interests, for example paid employment.

I'm in Canada, so I don't know what happens to the 401k once you retire.  If it's anything like RRSPs in Canada, at age 71, they get converted to some type of registered retirement income fund.  Nothing changes to the investments except that you have to start making withdrawals every year instead of making contributions.  The withdrawals can be in cash or in kind, where you withdraw an investment out of the registered fund into a non-registered account.  From that account, you'll continue to receive the income in dividends or interest. 
 

Anyone with an RRSP needs to look at the percentages in the schedule withdrawal table and factor in the tax impacts of having to withdraw minimums starting at age 71.  This can greatly impact your decision to continue to add to the RRSP past a certain point.  Way to many factors to list in one reply but you might be shocked at how much they force you to take out if you never looked.

sleepyguy

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Re: Living off investments: is it really this simple?
« Reply #20 on: May 28, 2014, 09:45:23 AM »
Agreed, the forced withdrawal is kinda poor imho with RRIF.  TSFA is a very good balance as with basic non-reg accounts if you keep your allocations correct (tax on non-reg accounts).  Here is a good list of the RRIF breakdowns

http://retirehappy.ca/should-rrif-minimums-be-changed/

In Canada OAS and CPP is also quite good for seniors (65 or 67) at about avg $16k/yr... so a couple is pretty much getting $32k/yr (taxed).  Factor that in, lower your spending and you can see Canada it's quite easy to retire frugal and happy.  Obviously for amount will be very low for us FIRE peeps but this info for general population.

So as you can see if your a Canadian... working minimum wage until 65-67 ... you really don't have to save even a single penny...  “The most you will receive from the government is $24,346.44 if you have no other sources of income and only $16,684.92 if you have other sources of income. Clawback and contribution rules may reduce these amounts.”




where does the income tend to come from? Can it be 100% dividends, even the dividends from the 401k?  Or is it partly dividends and partly selling stocks within the SWR from some non-retirement account? 

I don't agree you'll have to sell your investment for income.   That's the whole point of saving for retirement, your investments grow until such time that they produce a passive income, which can be dividends or interest.   If you just start selling your investments to use as income, you need an other source of income to make up reduction in dividends and interests, for example paid employment.

I'm in Canada, so I don't know what happens to the 401k once you retire.  If it's anything like RRSPs in Canada, at age 71, they get converted to some type of registered retirement income fund.  Nothing changes to the investments except that you have to start making withdrawals every year instead of making contributions.  The withdrawals can be in cash or in kind, where you withdraw an investment out of the registered fund into a non-registered account.  From that account, you'll continue to receive the income in dividends or interest. 
 

Anyone with an RRSP needs to look at the percentages in the schedule withdrawal table and factor in the tax impacts of having to withdraw minimums starting at age 71.  This can greatly impact your decision to continue to add to the RRSP past a certain point.  Way to many factors to list in one reply but you might be shocked at how much they force you to take out if you never looked.
« Last Edit: May 28, 2014, 10:09:53 AM by sleepyguy »

iampatriciag

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Re: Living off investments: is it really this simple?
« Reply #21 on: May 28, 2014, 02:15:10 PM »
I'm beginning to see...

I think it's preferable to sell and take capital gains on it instead of taking straight dividends

But to realize those capital gains, you have to sell stocks, right?  And that's different from this situation below with bonds (which I now realize I need to read up on), yes?

If bonds and dividends provide enough income, you never sell anything ... A more realistic strategy is living off of yield and selling either bonds or stocks to maintain a stable asset allocation. 

Are 'yields' here the same thing as gains?



EscapeVelocity2020

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Re: Living off investments: is it really this simple?
« Reply #22 on: May 28, 2014, 04:21:19 PM »
If bonds and dividends provide enough income, you never sell anything ... A more realistic strategy is living off of yield and selling either bonds or stocks to maintain a stable asset allocation. 
Are 'yields' here the same thing as gains?

I mean yield as interest and dividends, then meeting the rest of the income requirement by selling either bonds or equities, whichever is overweight in your target asset allocation (i.e. stocks if they have appreciated, bonds if stocks declined).  To maintain asset allocation, it may be necessary to rebalance further (selling additional equities to buy bonds, or vica versa).  This is the basic strategy to both provide income and to keep your portfolio in line with your risk tolerance.

iampatriciag

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Re: Living off investments: is it really this simple?
« Reply #23 on: May 29, 2014, 09:54:34 AM »
Thanks for taking the time to break it down like this!  I'm glad to have some better understanding and this community on hand to keep learning from!

DoubleDown

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Re: Living off investments: is it really this simple?
« Reply #24 on: May 29, 2014, 01:13:36 PM »
One other thing is it's fairly common to have at least two general buckets of investments: "Old (wo)man money" and "young (wo)man money." Young man money is generally taxable investments and accounts (plain old stocks, bonds, mutual funds held in brokerage accounts, real estate), while old man money is tax-advantaged accounts like 401k's and IRAs.

Typically, you could draw down on principal of the taxable accounts, and even deplete them completely, until you're 59.5 and eligible to start withdrawing from your 401k/IRA without penalty*. On balance, though, the old man accounts should go up as much as, or more than, you're taking out of the young man accounts. So, if you depleted your taxable accounts by $400k to cover living expenses until you reached 59.5, then your 401k/IRA will hopefully have gone up by at least $400k (in real, inflation-adjusted dollars) in that time. At that point, you switch to withdrawing from those accounts to cover your living expenses.

Therefore, you don't have to be too concerned about eating through the principal of certain accounts as long as your total net worth is mostly remaining the same, or hopefully even going up**.

* You can also access 401k's and IRAs before age 59.5 and without penalty using the various methods like 72t withdrawals and Roth conversion pipeline.

** There could also be fluctuations in your net worth, of course, due to market swings. It will not likely be a perfect straight line. Over the long haul, though, by following a Safe Withdrawal Rate like 4%, one should hope their net worth remains the same or increases.

EscapeVelocity2020

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Re: Living off investments: is it really this simple?
« Reply #25 on: May 29, 2014, 09:35:23 PM »
I'm only re-posting because this is quite important and not discussed very often here.

Someone doesn't read Investor Alley too often. It's only discussed in every other thread.

Not trying to be snarky, but toss in a link (or a few).  'Tis true that I don't scour MMM forums for all of the similar threads (which is why I like Early-Retirement.org and Boggleheads.com, but I'm trying to be helpful here and, since it's mostly do-it-yourself around here, it's good practice to do the same, eh?