Author Topic: Ive decided on vanguard, but need some help please.  (Read 6385 times)

Dividend Youngster

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Ive decided on vanguard, but need some help please.
« on: March 08, 2015, 02:10:28 PM »
Alrighty so after many pain staking hours of deciding to go with index's over trying to pick stocks, ive decided index's fit the bill much better for the life style I plan on living.

A little background, im 24, own a 3 unit apartment house, live at home, my healthcare, car, car insurance, and phone is all paid by my work. What originally brought me to this point was dividend growth investing. A growing stream of income being produced by primarily dividend aristocrats.. the best in the business.

Come retirement, a steady stream of income that covers all of my expenses plus some is the absolute goal.
After doing some research, the vanguard ETF "VIG" looks like a promising option to me. despite the <2% div. The appealing thing to me is that for the past 10 years it has had an average annual return of 7%+. But now that im looking at it the other ETF im considering is VFINX. It doesnt pay a dividend but average annual returns for the past 10 years have also been over 7%.

Seeing that I am going to be in my accumulation phase for quite a while is there one that stands out against the other in an accumulation phase? Would something like holding VFINX in my taxable account and VIG in my simple IRA be tax advantageous?

Any help would be appreciated thanks!

Indexer

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Re: Ive decided on vanguard, but need some help please.
« Reply #1 on: March 08, 2015, 02:30:22 PM »
VFINX isn't an ETF.  The ETF version of that is VOO.

I wouldn't start by just looking at 10 year returns.  I would start by figuring out your desired asset allocation.  So figure out what you want in terms of stocks, bonds, international stocks, etc.

Now the 500 index isn't a bad place to start.  Its pretty well diversified and low cost.  If you like it you might also like VTI.  Same concept but its over 3000 more stocks in it for the same cost. 

In terms of tax efficiency there shouldn't be a big difference between VOO and VIG.  They are both domestic stock index funds.  So there should be little or none capital gains, and as noted the dividend on both is pretty low.  In terms of tax efficiency your domestic and international stock index funds are normally the most efficient.  If you have to have something in your taxable account that is what you want.  What you don't want are bonds or actively managed funds in your taxable account.  Bond income is taxed at ordinary income rates and active funds spit out a lot of capital gains, sometimes even short term capital gains so those are best parked in your IRAs.

Dividend Youngster

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Re: Ive decided on vanguard, but need some help please.
« Reply #2 on: March 08, 2015, 02:38:55 PM »
Perfect that gives me some places to start. Thank you very much!

waltworks

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Re: Ive decided on vanguard, but need some help please.
« Reply #3 on: March 08, 2015, 11:39:29 PM »
Go read a bunch at Bogleheads. Dividend investing is probably a dumb idea if you're in the accumulation phase. You can make a fairly strong argument that it's a dumb idea period and just investing in the entire index (at whatever your preferred asset allocation is) is better. A few good threads here on that topic:
http://forum.mrmoneymustache.com/investor-alley/dividend-portfolio-vs-index-fund/
http://forum.mrmoneymustache.com/investor-alley/help-with-approach-to-retirement-funding-swr-dividend-vs-bogleheads-investing/
http://forum.mrmoneymustache.com/investor-alley/do-you-own-nothing-but-dividend-stocks/

There are many others, as well as lots of discussion of the topic around the web.

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skyrefuge

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Re: Ive decided on vanguard, but need some help please.
« Reply #4 on: March 09, 2015, 10:58:04 AM »
But now that im looking at it the other ETF im considering is VFINX. It doesnt pay a dividend

VFINX (aka VOO, aka VFIAX) most definitely pays a dividend. Its current yield is 1.96%, a completely negligible difference from VIG's 2.01%. As Indexer notes, VTSAX/VTI, Vanguard's Total Stock Market Fund is an even better choice (S&P 500 funds like VFIAX/VOO are historical relics made obsolete by VTSAX/VTI), and has a 1.79% yield.

That said, those dividend yields should be irrelevant in making your investment decision, because the dividend yield on its own doesn't tell you anything useful (except how much you'll pay in taxes in a taxable account). Just invest in VTSAX/VTI.

Dividend-focused investors somehow haven't noticed, but companies already have made a strong shift away from dividends as their preferred method of returning money to shareholders; buybacks are now the main vehicle for that return. By the time you've retired, it's entirely possible that no one will be paying dividends. They won't have stopped making money and returning it to shareholders, they'll just have changed the delivery method. And you'll be sitting there starving (despite your giant investment pile) because you made an arbitrary commitment years earlier to only spend money that comes from these things called "dividends".

So focusing on dividends now is like spending the next 20 years learning electronics and spending countless hours and lots of money to build the world's highest-fidelity Compact Disc* player, so that you can listen to awesome music that will be coming out in 2035. Given that the Compact Disc already ceased being the primary delivery method for music a decade ago, it's almost guaranteed that no one will be delivering music that way in 2035. But just like changing delivery methods haven't stopped the creation of music, changing delivery methods in the stock market won't stop the creation of value.

So people promoting dividend-focused strategies are essentially like old people who haven't yet realized that Compact Discs no longer matter.

If what you care about is music and money, binding yourself to a particular delivery method is foolish. In the music world, I've shifted from Compact Discs, to buying mp3 files, and now to streaming via Spotify. The financial world is easier, and doesn't require you to track the changing delivery methods on your own. Just invest in a total market fund like VTSAX/VTI; it will automatically keep up with the trends of the day, and your total return will match that of the market.

* Since you're only 24, Compact Discs may be just as foreign to you as dividends may be to a 24-year-old in 2035! http://en.wikipedia.org/wiki/Compact_disc

Wolf359

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Re: Ive decided on vanguard, but need some help please.
« Reply #5 on: March 09, 2015, 03:23:12 PM »
But now that im looking at it the other ETF im considering is VFINX. It doesnt pay a dividend

VFINX (aka VOO, aka VFIAX) most definitely pays a dividend. Its current yield is 1.96%, a completely negligible difference from VIG's 2.01%. As Indexer notes, VTSAX/VTI, Vanguard's Total Stock Market Fund is an even better choice (S&P 500 funds like VFIAX/VOO are historical relics made obsolete by VTSAX/VTI), and has a 1.79% yield.

That said, those dividend yields should be irrelevant in making your investment decision, because the dividend yield on its own doesn't tell you anything useful (except how much you'll pay in taxes in a taxable account). Just invest in VTSAX/VTI.

Dividend-focused investors somehow haven't noticed, but companies already have made a strong shift away from dividends as their preferred method of returning money to shareholders; buybacks are now the main vehicle for that return. By the time you've retired, it's entirely possible that no one will be paying dividends. They won't have stopped making money and returning it to shareholders, they'll just have changed the delivery method. And you'll be sitting there starving (despite your giant investment pile) because you made an arbitrary commitment years earlier to only spend money that comes from these things called "dividends".

So focusing on dividends now is like spending the next 20 years learning electronics and spending countless hours and lots of money to build the world's highest-fidelity Compact Disc* player, so that you can listen to awesome music that will be coming out in 2035. Given that the Compact Disc already ceased being the primary delivery method for music a decade ago, it's almost guaranteed that no one will be delivering music that way in 2035. But just like changing delivery methods haven't stopped the creation of music, changing delivery methods in the stock market won't stop the creation of value.

So people promoting dividend-focused strategies are essentially like old people who haven't yet realized that Compact Discs no longer matter.

If what you care about is music and money, binding yourself to a particular delivery method is foolish. In the music world, I've shifted from Compact Discs, to buying mp3 files, and now to streaming via Spotify. The financial world is easier, and doesn't require you to track the changing delivery methods on your own. Just invest in a total market fund like VTSAX/VTI; it will automatically keep up with the trends of the day, and your total return will match that of the market.

* Since you're only 24, Compact Discs may be just as foreign to you as dividends may be to a 24-year-old in 2035! http://en.wikipedia.org/wiki/Compact_disc

Compact Discs?  I still miss vinyl!

Dividend Youngster

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Re: Ive decided on vanguard, but need some help please.
« Reply #6 on: March 09, 2015, 04:15:36 PM »
Ive been doing a lot of reading and I dont disagree that when it comes to the math, whether you invest in a dividend stock vs a company that pays no dividend is irrelevant as far as returns are concerned. The thing that plagues my mind is what happens come retirement and you need that pay check. What if you retire in 2008-9 and your portfolio takes a 20-30% hit you still need to sell off shares but you eat into your principle amount. Whereas dividend companies (and im pretty much only focused on aristocrats, which maybe not so coincidentally alot of these ETF's are primarily made up of) may reduce or eliminate their dividend but you are still receiving income from the others. You would sell off the ones that eliminate or decrease the dividend and allocate the proceeds to other dividend paying stocks while not affecting your principle amount nearly as much for when the market returns. Again im not arguing that returns are greater with div's or that there is free money to be had. But in the end game I think div's are a better bet.
As far as divs being old cd players, is a little too speculative imho, you never know share buybacks could be the zune of the ipod world :P And as you also said if div's do go by the wayside "and youre sitting on a giant investment pile" you could liquidate that just as well

I personally think ETF's that follow the broader market are a greater way to earn a better a return, considering you beat 50% of the market. But div's imho are a superior end game strategy.

I know how passionate skyrefuge you are about indexing, so your following post youre probably going to try and beat it into me that indexing is better in every way. However, ive been through at least 50 different forum discussions addressing the topic and I havent seen anything yet that makes me think any different as far as the END GAME is concerned.

Ready, go!

skyrefuge

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Re: Ive decided on vanguard, but need some help please.
« Reply #7 on: March 09, 2015, 06:57:51 PM »
What if you retire in 2008-9 and your portfolio takes a 20-30% hit you still need to sell off shares but you eat into your principle amount.

If you truly understand the math, then you know that companies eat into your principal amount when they pay out a dividend, so your principal gets eaten equally in either case. If a company that doesn't pay dividends takes a 30% hit during a market crash, then a twin of that company, whose only difference is that they pay out dividends rather than retaining their earnings, would also take a 30% hit.

If you're assuming that your dividend-paying company would only take a 10% hit while the broad market drops 30%, that's because you're assuming a different company, with different characteristics.  It's may be possible to find a set of stocks that are less volatile than another set, and many of them would probably pay dividends, but it's not their dividends that make them less volatile, no more than being encoded as pits on a plastic disc is what makes good music. In other words, while dividends may correlate with lower volatility, they're are not the cause. Things like earnings, company maturity, market share, industry, etc. are more likely to be predictive of lower-volatility than dividend payouts. Sometimes these qualities all converge on "value stocks". If "dividends" are the only thing you screen with, you'll needlessly throw stocks that are just as good at meeting your goals, but who use buybacks instead of dividends. So if you're going to screen for low-volatility stocks, it makes a lot more sense to screen directly for those inherent qualities rather than focusing on the earnings-return mechanism.

But, good luck finding those low-volatility stocks. As depressing of a strategy as it would be to limit yourself to music that you could buy on CD at Wal-Mart, picking non-volatile stocks based solely on their dividend history might be even worse. Here is how three ETFs based on various flavors of dividend-aristocrat indexes performed compared to the total market during '08-'09. One fell less, one fell about the same, and one fell more. If you can explain why the 2006 version of you would have known that that one dividend index was the one to pick, and the other two were garbage, I would love to be enlightened!

Then, even if you do manage to find a way to discover low-volatility stocks, you're almost surely increasing your risk by lowering your diversification.

As far as divs being old cd players, is a little too speculative imho, you never know share buybacks could be the zune of the ipod world :P

Yes, of course, that's why I said you should just invest in a total market fund and embrace the total return, because whether the world ends up moving towards Zunes or moving towards iPods, you'll win either way, automatically.

And as you also said if div's do go by the wayside "and youre sitting on a giant investment pile" you could liquidate that just as well

Well yeah, that's exactly what an investor who gave no special status to dividends would do. But you've expressed fear of "eating into your principal", which suggests you're unwilling to take such a course. Have you changed your mind halfway through this post, and realized that there is nothing dangerous about "eating into your principal" before I've even finished my response? Damn, I'm good!

I know how passionate skyrefuge you are about indexing, so your following post youre probably going to try and beat it into me that indexing is better in every way. However, ive been through at least 50 different forum discussions addressing the topic and I havent seen anything yet that makes me think any different as far as the END GAME is concerned.

Well yes, you literally have incorporated dividends into your personal identity, so I expected it might be difficult for you to see the rewardless-risk that you get from a dividend-focused approach. Just like it was impossible to make SUV-luvvvr to see that buying a used Honda Fit would be a huge boon for her financial goals. But at the least, maybe other less-invested readers will learn something from the discussion.

If you've read 50 different forum discussions, then surely you've come across this, but maybe read it again:

Vanguard's Total-return Investing whitepaper

Pages 8-14 is even all you really need to read. It essentially repeats what I've already said, showing how you get no reward with a dividend-focused approach over a total-return approach, while you add diversification risk. But maybe hearing it from someone who offers dividend-focused funds will make it seem less-biased to you.

If lower volatility during the withdrawal phase is your goal, and you're willing to accept lower returns in exchange, just increase your bond allocation. Problem solved.
« Last Edit: March 09, 2015, 08:13:41 PM by skyrefuge »

waltworks

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Re: Ive decided on vanguard, but need some help please.
« Reply #8 on: March 09, 2015, 07:28:15 PM »
God I get sick of trying to explain the world to "I can't eat into my principle!" people.

If your principal grows faster than inflation over the long run, you can eat into it until the cows come home. All that matters is total return. Trying to pick dividend stocks arguably lowers that return and definitely reduces the diversity of your holdings. So a small net loss, for extra work on your part. If you like that sort of thing, you can pay me to cut my lawn.

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Dividend Youngster

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Re: Ive decided on vanguard, but need some help please.
« Reply #9 on: March 10, 2015, 06:20:35 AM »
This is directly from vanguard's website
"Third, the rule of thumb assumes a dollar inflation–adjusted spending program. This means that, at retirement, the retiree spends 4% of his or her portfolio and adjusts that amount annually for inflation. In reality, very few retirees actually stick with such a strict policy. Further, and more important, following an inflation-adjusted spending strategy exposes the retiree to “sequence of returns” risk. With such a model, the spending amount is adjusted annually for inflation but completely ignores portfolio performance. In periods of sustained poor market performance, particularly at the onset of retirement, the retiree is actually spending a greater percentage and, if left unchecked, exposes the portfolio to premature depletion. Indeed, this is one of the major risks of the 4% spending rule."
This is a legitimate concern, DIRECTLY FROM VANGUARD THEMSELVES. Perhaps you would have a better chance at getting people to put their money in index's vs stocks if you treated these concerns a little more constructively. Everything you have said about index's I agree with, but the thing you failed to convince me of is the end game as described "may expose the portfolio to premature depletion." Directly from F%^&ing vanguard.

" God I get sick of trying to explain the world to "I can't eat into my principle!" people. " Maybe you should explain that to vanguard?

And to be clear I am exploring all avenues to put my money and having these concerns is legitimate and asking the questions is the smartest thing I can do. And to be perfectly honest I WANT TO PUT MY MONEY IN INDEX'S I like everything about them except for the major risks described by vanguard.

brooklynguy

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Re: Ive decided on vanguard, but need some help please.
« Reply #10 on: March 10, 2015, 07:11:24 AM »
If a company that doesn't pay dividends takes a 30% hit during a market crash, then a twin of that company, whose only difference is that they pay out dividends rather than retaining their earnings, would also take a 30% hit.

At the risk of providing fodder to proponents of dividend-focused strategies, I think this statement highlights what in my view is the only plausible potential flaw in the otherwise unassailable logic behind the argument that dividends do eat into principal to an equal extent:  that argument presupposes the efficiency of the market, which is not a logically necessary truth.

In your twin company hypothetical, the reason for the identical performance of the dividend-paying company and the earnings-retaining company is that the market recognizes the fact that the payment of the dividend leaves the company poorer by an amount equal to the total dividend payout and therefore reduces the market value of the company by a corresponding amount.  But what if the market were not efficient enough to absorb this information?  What if it were so grossly inefficient that the market completely failed to price the occurrence of the dividend payment into the share price?  In that case, the dividend would represent a free lunch, at least until the market price self-corrects to reflect the decrease in the company's intrinsic value.

The answer to this line of counter-argument, though, is that it is completely divorced from reality.  The stock market is in fact highly efficient, and certainly efficient enough to correctly reflect so obvious a change in the intrinsic value of a company as a divestment of its cash in the form of a dividend payment to its public shareholders.

Moreover, even if the market were not so efficient, the market's misvaluation could cut in either direction:  as long as we're accepting the existence of alternate reality where the market can fail to recognize the decrease in value caused by the parting of a company and a portion of its cash holdings, then that fantasyland market could just as easily undervalue the shares after the occurrence of a dividend as overvalue them, in which case the non-payment of a dividend would be providing a free lunch.

brooklynguy

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Re: Ive decided on vanguard, but need some help please.
« Reply #11 on: March 10, 2015, 07:21:52 AM »
[Vanguard quote and frustrated plea for enlightenment...]

If you understand and agree with the idea that payment of dividends eats into your principal to the same extent as selling an equivalent amount of your shares, then why does a dividend-focused portfolio have a lower chance of "premature depletion" than a non-dividend-focused portfolio?

Dividend Youngster

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Re: Ive decided on vanguard, but need some help please.
« Reply #12 on: March 10, 2015, 07:31:31 AM »
[Vanguard quote and frustrated plea for enlightenment...]

If you understand and agree with the idea that payment of dividends eats into your principal to the same extent as selling an equivalent amount of your shares, then why does a dividend-focused portfolio have a lower chance of "premature depletion" than a non-dividend-focused portfolio?

Thanks for your post Brooklyn, this is pretty much what I am struggling with, I'm not so sure that I fully understand how dividends eat into your principle if you don't plan on ever selling a dividend paying stock unless it cuts or eliminates the div all together.

brooklynguy

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Re: Ive decided on vanguard, but need some help please.
« Reply #13 on: March 10, 2015, 08:08:44 AM »
Thanks for your post Brooklyn, this is pretty much what I am struggling with, I'm not so sure that I fully understand how dividends eat into your principle if you don't plan on ever selling a dividend paying stock unless it cuts or eliminates the div all together.

The reason you are struggling with the concept is the intense, difficult-to-resist emotional seduction of the idea that owning a share of a dividend-paying stock is like owning an egg-laying chicken:  you bought the chicken for its eggs, and you don't want to kill the chicken (sell the share) if you want to keep collecting eggs.  Although this notion holds strong emotional appeal, it reflects a misunderstanding of how stocks and dividends work.  This post by grantmeaname is the clearest explanation I've seen in this forum for why the receipt of dividends constitutes the slaughtering of the chicken just as surely as the selling of shares (but for the best (and wittiest) overall explanations of these concepts you should simply peruse through skyrefuge's entire posting history).  After you've read that post, if you still have questions come back and ask us and we will help you to see the light (and I will pass the baton back to skyrefuge, since no-one does better job of shedding light on this subject than him).

waltworks

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Re: Ive decided on vanguard, but need some help please.
« Reply #14 on: March 10, 2015, 08:12:30 AM »
Selling when the company is in trouble and can't/isn't paying dividends, eh?

Think through the logic of that strategy for a minute.

Listen, if you are reinvesting your dividends, then you're ending up with more capital, right? Just like holding a stock that appreciates faster. If the company doesn't hand the money out to shareholders, does that make the company more or less valuable?

Think of it this way:
-Company Y makes $100 million profit a year. They choose to keep that money to invest in new projects and equipment.
-Company X makes the same profit, and has the same basic infrastructure/holdings and business - and distributes the profits to the shareholders.

Now, which company would you pay more to *buy outright* as a big-shot capitalist? The one with $100 million in the bank, or the one with an empty bank account? Furthermore, which one has better prospects going forward? Obviously it's a ridiculous example but paying dividends reduces the value of the company by *exactly* the amount of the dividend. It's basic accounting!

-W

skyrefuge

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Re: Ive decided on vanguard, but need some help please.
« Reply #15 on: March 10, 2015, 10:27:03 AM »
This is a legitimate concern, DIRECTLY FROM VANGUARD THEMSELVES. Perhaps you would have a better chance at getting people to put their money in index's vs stocks if you treated these concerns a little more constructively. Everything you have said about index's I agree with, but the thing you failed to convince me of is the end game as described "may expose the portfolio to premature depletion." Directly from F%^&ing vanguard.

Yes, if you spend more from your portfolio than the portfolio can reliably sustain, your portfolio will be depleted prematurely. This is true whether your portfolio is a total market index fund, or a dividend-focused fund. Or US treasury bonds, or marijuana stocks, or a pirate's treasure chest of gold and jewels, or a herd of alpacas. Surely you noted that Vanguard did NOT conclude that piece by saying "...and the way to avoid this sequence-of-return risk is to invest only in dividend-paying stocks". That's because they know a dividend-focused strategy is no more protected from depletion than an alpaca herd is. Sequence-of-return risk is an inherent, unavoidable risk of being invested in any assets which can be re-valued by a market.

The only sure way to avoid the risk of premature portfolio depletion is to use that portfolio to buy insurance that guarantees a particular income stream for life. This is known as an annuity. It will cost you a lot to shift that risk from you to the insurance company, but if that risk keeps you otherwise paralyzed in fear, then it could be a viable option for you.

The next-best thing is to build up your portfolio to an extreme size, so that your yearly expenses are only a small fraction of its value, like 2%. This is the only way that a "live-off-the-dividends" approach reduces your risk, but again, it's not actually the dividends that are causing that risk-reduction. It's the fact that, in order to live off the dividends at the current ~2% dividend yield, your portfolio needs to be twice the size than if you're following the 4% rule-of-thumb. A portfolio 2x larger than another is going to have a lower risk of depletion no matter what type of asset it holds. But again, acquiring such a portfolio comes at tremendous cost: many more years of working, which are likely to be totally unnecessary.

Because remember that the 4% rule-of-thumb already incorporates sequence-of-return risk. It's not like they came up with 4%, then said "oh, shit, we didn't think of sequence-of-return risk! Maybe it should really be 2%?" It's actually the opposite: the 4% SWR research was performed to show the effects of sequence-of-return risk to those who, at the time, were advocating much-higher SWRs!

skyrefuge

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Re: Ive decided on vanguard, but need some help please.
« Reply #16 on: March 10, 2015, 11:57:34 AM »
This post by grantmeaname is the clearest explanation I've seen in this forum for why the receipt of dividends constitutes the slaughtering of the chicken just as surely as the selling of shares

Yes, please read grantmeaname's post. And now I'll extend it to focus on the "end game" (withdrawal phase), which I've been trying to focus on for this whole thread, since I know that's what's the sticking point for you.

We'll say that at the end of 2015, both Divcorp and Capgains are valued by the market at $1M, and each company has expected earnings of $60k per year (6%). In December 2016, a nuclear weapon explodes in Cleveland. While some knuckleheads cheer ("it's about time!" "I think the fallout actually *improved* things!"), most of the world sees that the population loss and oncoming military action are going to have an enormous effect on consumer behavior, and far fewer people will be buying the awesome fluorescent slap-bracelets that both Divcorp and Capgains make all their money on. Everyone recognizes that the future earnings of the two companies are likely to be cut in half to $30k/year. So those who are unwilling to accept those lower returns sell their holdings. This selling pressure causes the price of both companies to fall dramatically.

Once the price reaches a level where the earnings are sufficient to produce that original 6% return-on-capital, it stops falling, because that's now an acceptable return for investors in the market. But let's see how far they've actually fallen. Both companies made $60k in 2016, and Divcorp paid out its normal $50k in dividends at the end of the year despite the oncoming war. So its market value in January 2017 is $510k ($30k/6% = $500k, plus the $10k in retained earnings). A drop of 49%. But Capgains retained all of its earnings as usual, so its market value in January 2017 is $560k ($30k/6% = $500k, plus the $60k in retained earnings). A drop of only 44%.

So you see that in a "market crash", Divcorp crashes harder.

Of course, this doesn't make Capgains "better" than Divcorp, because Divcorp provided you with retirement income via its dividend. But when you are forced to "eat into principal" of your Capgains holding to fund your retirement, you do so from a position where Capgains has fallen less-far than Divcorp. "Eating into Capgains' principal" at that point only makes your holding shrink to be as small as Divcorp, not smaller. Your eaten-away holdings in both companies will have an equally hard time recovering from those losses; neither is in a stronger position than the other.

I agree that the behavior of stocks during a crash/withdrawal is seldom detailed like this in a dividend discussion, so hopefully this theory, combined with the visual proof that that's how the theory also works in practice, helps you understand why dividends don't protect you against market crashes during the withdrawal phase.

Dividend Youngster

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Re: Ive decided on vanguard, but need some help please.
« Reply #17 on: March 10, 2015, 03:04:15 PM »
believe it or not that was the example I was looking for in all of this skyrefuge, i understood the examples given in a market that is appreciating but there werent really many examples during a down turn.

Thank you!