Question for those planning on 4% with index funds

[Ricky]

With index funds, you own a certain number of shares whether it is through a mutual fund or an ETF. In this case you are banking on the majority of your gains coming from capital gains rather than direct dividend distributions. So, that said, you will be dwindling down your shares over time. What happens when there is only one share left? This is what has me confused with this style of investing.

[dandarc]

1.  Mutual fund "shares" are divided way more thinly than 1 share.  I just transferred 93.837 shares of one of my mutual funds to another broker.

2.  Even with ETFs, there are brokers that let you trade fractional shares.  Sharebuilder, for one.

3.  I believe that both ETFs and Mutual funds could do a stock-split if they felt the per-share price was too high, just like any other company.

So if there is only one share left, nothing other than you're basically out of money. Unless of course that single share is worth a lot - if I only had one share of BRKA (granted not a mutual fund or ETF, but that 1 share is worth $217K today), I'd be far from broke.

[dandarc]

And if you're reinvesting dividends, your number of shares isn't necessarily dwindling down to nothing any way.

[Friar]

When I buy my index funds, rather than purchasing a number of shares, I'll buy a nice rounded amount. £100 for example.

This leaves me with fractions of a "share" of the index fund itself.

I don't think this is an issue as all you're really doing is putting that £100 into a big pot that you get a percentage of. When you sell a bit of it all you're doing is reducing the percentage that you own.

If you were to be left with exactly 1 share and sold 0.2 of it, then you'd be left with 0.8 of a share :P

I'm not sure how it works when buying or selling shares in a company directly though. Maybe you can only buy and sell in whole shares.

[Ricky]

Yeah I forgot to preface my question by adding the assumption that you will have not touched principle. I do realize that it is going to be pretty rare for this to happen and end up with 1 share worth what your original investment was, but it is sort of a mind bender.

I am also assuming that you're in withdrawal phase (not re-investing dividends)

Also totally forgot about fractional shares - so I guess that is the answer.

[forummm]

While the number of shares might be declining, the total value of the shares remaining may actually increase over time as the value of the shares increase.

It's impractical for Vanguard to have ETFs that cost $1 million. They will split them eventually. The same will happen with mutual funds if they get too expensive.

[Eric]

If you get down to only one share, then you're broke.  Hopefully you made it to SS age.  Otherwise, VTSAX pays about 1.8X% dividend.  So if you're looking at a majority of your income by selling shares, it's only slightly more than the dividend yield.  So while majority is the correct term, it's closer to a 50/50 split.  Not that it matters.  Whether you're taking 4% in dividends, selling 4% in capital gains, or some combination in between, the net effect on your portfolio is exactly the same.

[Ricky]

If you get down to only one share, then you're broke.  Hopefully you made it to SS age.  Otherwise, VTSAX pays about 1.8X% dividend.  So if you're looking at a majority of your income by selling shares, it's only slightly more than the dividend yield.  So while majority is the correct term, it's closer to a 50/50 split.  Not that it matters.  Whether you're taking 4% in dividends, selling 4% in capital gains, or some combination in between, the net effect on your portfolio is exactly the same.

This is very true. It's just that with taking dividends you aren't selling shares. But either way, you're right, probably not going to happen anyway.

I'm just imagining a situation in which you have one share valued at your initial purchase price (after inflation) years down the road. This may not be possible in one person's lifetime, given the amount of times the fund may split it's shares, but it just seems like over a really long period of time, this would happen? I guess even if that happened you would be withdrawing fractions to the point of something stupid like 0.000001%.

What brought up this question was someone comparing dividend investing to picking the fruit off of a tree. I wondered why they made that analogy with dividends and not investing in general.

[sol]

They made that analogy because they didn't understand the difference between capital growth and dividend payments, both of which come directly from the profits of the underlying companies.

Or they did understand it, and just failed to mention the distinction because they already know they are identical.

[forummm]

What brought up this question was someone comparing dividend investing to picking the fruit off of a tree. I wondered why they made that analogy with dividends and not investing in general.

Some people have an emotional reaction to selling shares. It feels like selling the principal to them. So they focus on only having high-dividend stocks. Unfortunately that may leave their portfolio to gain less over time and/or be more risky, due to missing out on stocks that grow a lot but don't pay dividends.

[brooklynguy]

What brought up this question was someone comparing dividend investing to picking the fruit off of a tree. I wondered why they made that analogy with dividends and not investing in general.

Another common false analogy used to illustrate the incorrect notion that dividends don't "eat into principal" is to compare dividend-paying stocks to egg-laying chickens.  But the image now seared into my brain is the dollar-shitting goose.  That parable by skyrefuge is well worth reading to get a good grasp of why there's nothing magical about dividends.

[innerscorecard]

Don't think in terms of the number of shares. Think in terms of what that actually represents. Hard for people to do, of course.

[MoneyRx]

While the number of shares might be declining, the total value of the shares remaining may actually increase over time as the value of the shares increase.

It's impractical for Vanguard to have ETFs that cost $1 million. They will split them eventually. The same will happen with mutual funds if they get too expensive.

This is the answer

[J.Milly]

Well dividends and capital gains are fairly similar. With Net Income a company can disburse some cash(dividend) or keep it as retained earnings and reinvest it in itself (which hopefully causes an increase in the price of your company. People like dividends because they think its free money without having to sell off some of their nest egg.