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General Discussion => Welcome and General Discussion => Topic started by: DoubleDown on April 02, 2014, 12:56:27 PM

Title: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 02, 2014, 12:56:27 PM
For anyone who's mystified by the 4% Safe Withdrawal Rate (SWR), or who questions if it's too conservative or not conservative enough, or how they access their 4% annually once they're retired, or if they should include home equity in their net worth and annual withdrawals, or if they can just hit a "Number" and then retire, I suggest perhaps forgetting it and instead looking at it from the other angle: Retirement Income. That might make things a little more straightforward to understand.

I'd venture to say that very few real-life early retirees have paper equities as their sole asset, that they blindly withdraw 4% every year, no matter the circumstances (that scenario forms the basis for the theoretical "4% SWR"). More likely, early retirees will have a variety of income-producing assets or other income streams that they will access at different times. That's why a SWR only goes a little way to understanding what you need to retire, and when you can do so. Really, there are only three basic steps in deciding when you have "enough" to retire:

1. Determine how much you need/want to live on annually once you are retired. If you want to get extra fancy about it, you can break up "how much you will need" into more than one period. Say, you might need more while kids are in college, or when you are in a nursing home, or less while you're backpacking through Asia -- whatever works for your own circumstances.

2. Determine what your assets are worth, and what income (if any) they will or can generate for you in retirement (see below).

3. Decide when and how to tap into those assets during your retirement to cover your expenses. That is, devise income streams from your assets to cover the expenses you anticipated during the different stages in life, in Step 2 above.

We all probably already know that retirement income can come from a variety of sources: pensions, dividends on stocks, rental income on property owned, selling paper equities (stocks, bonds, etc.), Social Security, cash stowed under your mattress, part time work or other income-producing activities like selling stuff on eBay, etc. For each kind of asset you own, or intend to own in retirement, determine how much income it will generate, and when you will start using it to generate income. That's it -- once the income generated from those assets meets or exceeds your annual needs, you're ready to retire. No official SWR is required. You could get all of your income in the form or rents on properties you own, which makes an "SWR" meaningless; or 1/2 from rental property, 1/4 from selling stocks, and 1/4 from Social Security, or any other infinite combinations of things.

This will all be highly dependent on the kind of asset, of course. For example, you obviously can't start taking Social Security until you hit a minimum age, and even then you must decide if you want to take it early or wait until you are older for a higher monthly payment. In that way, you might decide to deplete stocks you own at a rate higher than 4% while you are younger, expecting that you will have additional income in the form of Social Security, 401k withdrawals, or pensions when you are older. Home equity in your primary residence provides Zero income unless you take a reverse mortgage, rent out a room, or sell your home. Again, the goal is to determine income streams for the different stages of your retirement, maximizing each asset for its intended purpose.

The only asset for which I use an "SWR" is equities. Even then, an SWR is not particularly relevant for me, because I intend to use up taxable equities at a rate much higher than 4% between my current age of 47, and then later stages in life when I have some other income streams that will start (401k, pension, rental income, selling rental property, and Soc. Security in my case). That way, I can let my 401k, pension and Soc. Security sit as long as possible, getting the most return when I'm older.

There will undoubtedly be some recalibrating and rebalancing every year along the way, but I've structured things in a way that will provide overall for the amounts of income I want during different stages of life. Personally, I've set it up for a pretty balanced income for the rest of my life, but I've slanted things a little heavily to having more income later in life. I've done this mostly as a risk-mitigation thing, not wanting to find myself doing the proverbial cat food-eating when I'm old. And I'm playing things a little safer for the first year or two to avoid any potential bad sequencing, and because I'm still relatively young and could go back to work if needed, and mostly because all our needs are met and I don't have any particular need to spend more.

Hope this helps, please feel free to poke holes or offer suggestions.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Nords on April 02, 2014, 01:19:46 PM
An alternative to the 4% SWR (annual expenses x 25) is the "living off the dividends" approach-- which is typically estimated at 3% or 33x.  If you want to be ridiculously conservative then you'd use the S&P500 dividend rate, which puts you up into 40x-50x territory.

Of course if you set up an income stream to cover your expenses-- annuity or rental property-- then SWR is irrelevant.  In any case it's also the dividend approach, and we just debate the value of the assets that create the income stream.

The issue between the two approaches is at least 8x your annual expenses.  Depending on your income, that could require a few more years of working.  Most people saving for ER are not very interested in continuing to work, so they might find the 4% SWR much more compelling. 
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Cottonswab on April 02, 2014, 01:29:53 PM
I agree with the OP, in principle.  However, I would recommend changing the title to state: "It is all about cash flow", rather than income.

People aiming to retire early would generally be better served by targeting a sustainable net positive cashflow from passive (or non-employment related) income, rather than a safe withdrawl rate (SWR). SWR studies are only applicable for stock & bond portfolios that are required to last a limited number of years.  Generally, these studies were targeted at "normal" retirees (i.e., people retiring in their 50s and 60s).  These studies also assume no income from other sources or significant increases in annual expenses, beyond general inflation.

Therefore, I highly recommend that anyone considering early retirement project out their future cashflows (until end of life), before electing to fully retire.  I find that spreadsheets are most useful for this purpose. 
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 02, 2014, 01:31:02 PM
No official SWR is required. You could get all of your income in the form or rents on properties you own, which makes an "SWR" meaningless; or 1/2 from rental property, 1/4 from selling stocks, and 1/4 from Social Security, or any other infinite combinations of things.

...

Hope this helps, please feel free to poke holes or offer suggestions.

The biggest hole is that how do you tell how much stocks to sell?  I.e. what rate is safe to make sure you won't run out of stocks, then have to take a (potentially unsustainable) 25% paycut.

This is where www.cfirsim.com comes in handy, IMO.

Put in any income from rental properties, etc. as an "other saving" input, and see what is sustainable.

Thinking blindly about some X% "SWR" is often too broad because you will have a more specific situation, I agree.

The other big issue with just thinking about it this way is that many who want to FIRE off of income, but don't want rentals, go for dividends.  This can lead to two potential issues:
1) They save way more than is needed (not necessarily a bad thing, but if they work years longer than they wanted to in order to do so, that's far from ideal) because of low dividend yields

or

2) They reach for yield, and pick poor stocks because they have high dividends.  This cases ER failure.

I think just thinking about income (specifically dividends) is actually detrimental to a good FIRE plan.

Again, cfiresim.com is the best way to go, IMO.  It will let you evaluate your specific scenario and AA and let you know what you can withdraw safely from the equities you have.

A 4% SWR is too simplified.  So is an "income only" plan.  Something like this shouldn't be over simplified.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: anisotropy on April 02, 2014, 02:10:02 PM
or.....have a pre-determined asset allocation and stick with it. For example, if by the time you retire you have 1M liquid asset and your yearly budget is 35k. Then an asset allocation that would work could be :

3.5% cash
30% Bond
66.5% Stock

if your investments make some money during the year and assets increases to 1.05M, rebalance at the beginning of the year and take out the cash.

if your invesetment loses money during the year and assets drops to 0.95M, you do the reverse. It'd be wise to have a nice cushion (20%?) if you use this method, that's what we are planning to do.

There are many ways to do this, i feel they are all more or less the same.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 02, 2014, 03:48:36 PM

The biggest hole is that how do you tell how much stocks to sell?  I.e. what rate is safe to make sure you won't run out of stocks, then have to take a (potentially unsustainable) 25% paycut.


I'd argue that as far as stocks go, there is no certain answer, only educated guesses based on historical data. If we're going to have money in stocks (and we should), then we never know with 100% certainty what will be absolutely safe to withdraw in the future. My best guess is "$ in stocks divided by the number of years you expect to live, recalibrated every year (then you die with $0 in stocks)." Or you could go with "4%" as a super safe bet. For me personally, I would never have a 70 - 100% stock ER portfolio -- far too much volatility for my tastes. I want a decent standard of living covered by much safer income streams like rental income, annuities/pensions, social security, so that I don't have to stress over the years about your good question. Then if stocks do indeed perform as I expect them to, with a 4% SWR, that will be bonus money so to speak. But I realize this approach might not be for others, and it could lead to working longer than you had to if you had perfect knowledge of the future.

This is where www.cfirsim.com comes in handy, IMO.
...

A 4% SWR is too simplified.  So is an "income only" plan.  Something like this shouldn't be over simplified.

Yes, +1 for cfiresim. I see it as one tool in the arsenal, though. The challenge with any plan is the assumptions that go into it. For example, we make assumptions about how our stock portfolio will perform over the long run (which cfiresim does using historical data); we make assumptions about inflation in the future; about whether our pension or Soc. Sec. will still be there 20 years from now; and so on. You have to go into this with the understanding that some assumptions may turn out to be wrong, and hopefully have enough safety margins and diversification to survive that.

I really don't mean to imply that an "income plan" is the only way to go, and that SWR is meaningless. Like Nords points out, they're really just two sides of the same coin. I'm really just trying to help those confused by the SWR, offering up another way of thinking about the "how do I pay for things in retirement" question.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 02, 2014, 03:51:00 PM

Therefore, I highly recommend that anyone considering early retirement project out their future cashflows (until end of life), before electing to fully retire.  I find that spreadsheets are most useful for this purpose.

Amen, brother/sister! Same for me, good ol' spreadsheets give me exactly the picture I want of how to create income streams over the future years.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 02, 2014, 03:57:11 PM
or.....have a pre-determined asset allocation and stick with it. For example, if by the time you retire you have 1M liquid asset and your yearly budget is 35k. Then an asset allocation that would work could be :

3.5% cash
30% Bond
66.5% Stock

if your investments make some money during the year and assets increases to 1.05M, rebalance at the beginning of the year and take out the cash.

if your invesetment loses money during the year and assets drops to 0.95M, you do the reverse. It'd be wise to have a nice cushion (20%?) if you use this method, that's what we are planning to do.

There are many ways to do this, i feel they are all more or less the same.

I think that's a sound approach too, but personally I'm too much of a wuss to have an all-paper portfolio. I think I would not enjoy my freedom if we were going through a 2- or 3-year+ market downturn, and I'm selling stocks at bargain basement prices in order to convert to cash to live off. Yeah, I know that historically, they should go back up, I just would not enjoy going through that volatility. Meanwhile, I would have unexpected funeral and burial expenses because my wife would have died of a stroke or heart attack in the first month of a downturn!
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 02, 2014, 04:07:25 PM
DoubleDown is on the right track in my view.  Most folks I know that have retired or will soon retire with a portfolio of paper assets and a decumulation plan are spending a lot of time looking over their shoulder at the stock and bond markets.  It looks like the plan ought to work, but then there's that pesky sequence of returns risk to worry about and some valid reservations about the projected stock market growth rates in a mature economy being sustainable in the future.  Call it the bucket approach or the multi-legged stool, but I think acquiring assets that throw off sufficient income to support you without significant decumulation is the only was to feel secure about 40 years of retirement.  Pensions, real estate, dividend paying stocks, IRA RMD's and a general stock portfolio all work together to provide the income.  And the income plan is key.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: aj_yooper on April 02, 2014, 04:32:35 PM
Excellent discussion.  I like to think in terms of buckets over time. 

Always good to have two years of ER expenses covered (cash and other income as from a pension) as a way of managing a dismal sequence of returns.  Always good to have rental income as an inflation hedge, a cash flow, and to dampen market risks.  But the SWR% provides the motivation to save the money and a way to quantify when you are ready.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: MDM on April 02, 2014, 04:34:34 PM
Depends on the audience.  Just guessing, but I'd be willing to bet the OP and commenters so far in this thread all have retirement plans much better detailed than the average person's.

For folks who are lower on the learning curve (e.g., don't know historical spending), however, something simple like the "4% rule" can be used for gross range finding.

As some pretty smart folks once said, "...all models are approximations. Essentially, all models are wrong, but some are useful. However, the approximate nature of the model must always be borne in mind."  From the book: Empirical Model-Building and Response Surfaces (1987, p 424), by Box and Draper.  The quote is often shortened to the underlined portion, and is one of my favorites.

If we are discussing how to improve on the approximate 4% model, then good points from all previous posts.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: anisotropy on April 02, 2014, 04:46:38 PM
DoubleDown is on the right track in my view.  Most folks I know that have retired or will soon retire with a portfolio of paper assets and a decumulation plan are spending a lot of time looking over their shoulder at the stock and bond markets.  It looks like the plan ought to work, but then there's that pesky sequence of returns risk to worry about and some valid reservations about the projected stock market growth rates in a mature economy being sustainable in the future.  Call it the bucket approach or the multi-legged stool, but I think acquiring assets that throw off sufficient income to support you without significant decumulation is the only was to feel secure about 40 years of retirement.  Pensions, real estate, dividend paying stocks, IRA RMD's and a general stock portfolio all work together to provide the income.  And the income plan is key.

agree
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 02, 2014, 05:30:45 PM
*Sigh*

OP, what are you selling?  I feel compelled to ask because this sort of thing is so often the prelude to such.

Now that that is out of the way, I will say that A) it is unwise to throw out 50 years of scholarly efforts on this subject and B) I do not like the income approach because it tends to drive people to do stupid yield chasing.  I have watched a variety of retirement implosions due to various forms of idiot yield chasing (high dividend stocks, highly concentrated junk bond portfolios, various dopey options strategies, Venezuelan Beaver Cheese Futures...).  If you are trying to simplify, beware that those that prefer simple often are simple.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: happy on April 02, 2014, 05:50:52 PM
Great thread. I can't but agree how important planning in advance is.

Being one of Brewer's simple, I have arrived at NW 25x projected retirement expenses i.e. 4%SWR in theory, but due to lack of knowledge and planning prior to MMMing I am not able to retire due to lack of cash flow.  I could make a few radical changes right now and pull the trigger but the retirement would be lean and making those abrupt changes would mean some loss of efficiency. If I work another 4 and a half years or so part-time , reconfiguring, I can optimise taxes and a few other things and get a lot more margins of safety. I too plan on a combination of  income streams, that will change over time. The govt will likely keep tweaking rules as I go along, so I want to have the flexibility to rebalance or move in a few different directions.

So I think the "Just save 25x expenses and retire!" is great to get people started and moving, and stop analysis paralysis and so forth. Once you are up and running, use the accumulation time that seems oh so long to learn everything you can about finances and make detailed plans. I've found the complexity and sophistication of my plan and projections has hugely increased in the 2years+ I've been MMMing.

(Thanks everyone here who has helped as well as Mr MM).






Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 02, 2014, 07:03:50 PM
I have the utmost respect for Brewer12345's knowledge, but I can't follow how he came to his conclusion.  What DoubleDown says is not prefatory to a sales pitch.  He is merely recognizing the risks of focusing on the wrong thing.  So many people hear about the 4 percent withdrawal rate and the 25 x income savings goal, but they don't have a clue about what to do if and when they reach that target.  Usually some financial advisor/salesman gives them a piece of paper describing how to decumulate or tells them to buy an annuity, i.e. not a lot of real help.  I see this among the retirees and pre-retirees I know with large paper nest eggs but no pensions.  They are fearful and do not have a concrete plan for producing income that makes them feel secure.

Fifty years of scholarly efforts are interesting, but not reassuring when it comes to converting assets into income that shows up at regular intervals.  After all, haven't we all learned that past performance is not predictive of future results?  Sequence of returns risk is forefront in many peoples' minds because of what we just went through in the last 6 years.  Security is difficult to achieve with these thoughts running through your head.

The people that lead happy retirements from what I have seen generally have multiple streams of income - pensions, dividends, interest (ok, not so much of that right now), real estate income, residual income from the sale of a business or intellectual property, that sort of thing.  They are not feverishly running FIREcalc three times a day to "make sure."  They are not worried about running out of money because they are not planning a large decumulation.  They are also not investing in the exotic yield chasing investments Brewer12345 describes.  They don't have to, because they planned their income.

So, yeah, I think what DoubleDown says is right, spot on right.  Diversify your income streams because income, not assets, is what you eat.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 02, 2014, 07:15:45 PM
Fifty years of scholarly efforts are interesting, but not reassuring when it comes to converting assets into income that shows up at regular intervals.  After all, haven't we all learned that past performance is not predictive of future results?  Sequence of returns risk is forefront in many peoples' minds because of what we just went through in the last 6 years.  Security is difficult to achieve with these thoughts running through your head.

Plop your assets into a low cost 60/40 balanced fund, don't draw more than 4% inflation adjusted of your starting value, live a long and full life.  I just said it in one sentence which I had to make longer with comments about life because this isn't that complicated.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: ShortInSeattle on April 02, 2014, 07:33:21 PM
Fifty years of scholarly efforts are interesting, but not reassuring when it comes to converting assets into income that shows up at regular intervals.  After all, haven't we all learned that past performance is not predictive of future results?  Sequence of returns risk is forefront in many peoples' minds because of what we just went through in the last 6 years.  Security is difficult to achieve with these thoughts running through your head.

Plop your assets into a low cost 60/40 balanced fund, don't draw more than 4% inflation adjusted of your starting value, live a long and full life.  I just said it in one sentence which I had to make longer with comments about life because this isn't that complicated.

Yeah, that's basically how I view it too.  I know some folks feel more comfy with real estate income, or dividends only, or whatever, but so long as you asset allocation puts you at a rate of return that covers your withdrawal rate plus inflation, you're in pretty good shape I think.

Knowing your risk tolerance is important. I know plenty of ppl are comfy at 4% WR. I'm shooting for 3%.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 02, 2014, 07:42:15 PM
Even your friend Nords is hedging his bets by keeping the rental and juicing his stock returns by writing options.  The MM's live primarily on rental income, allowing the stock portfolio to grow for later and feeding it with work income.  Their retirement is likely going to be "overfunded."

You are an exception because of your professional knowledge and skill.  You can find a way to make your portfolio work under almost any scenario.  The average retiree has no clue how or if the conversion of assets to income is going to work, and is scared to death.  Most are in Happy's position - I achieved the asset target, now what do I do?  What DoubleDown is saying is plan the income while you are accumulating assets.  Focusing on acquiring assets and structuring them to provide long term income (with very low taxes and no decumulation) has worked well for me, and I retired a year before the SHTF in 2008.

Stop back when you and your friends are 65 so we 80 year-olds can ask "How's that working for ya?"  You may be fine, but I'll bet a lot of of your friends will not be.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 02, 2014, 07:56:29 PM
Even your friend Nords is hedging his bets by keeping the rental and juicing his stock returns by writing options.  The MM's live primarily on rental income, allowing the stock portfolio to grow for later and feeding it with work income.  Their retirement is likely going to be "overfunded."

You are an exception because of your professional knowledge and skill.  You can find a way to make your portfolio work under almost any scenario.  The average retiree has no clue how or if the conversion of assets to income is going to work, and is scared to death.  Most are in Happy's position - I achieved the asset target, now what do I do?  What DoubleDown is saying is plan the income while you are accumulating assets.  Focusing on acquiring assets and structuring them to provide long term income (with very low taxes and no decumulation) has worked well for me, and I retired a year before the SHTF in 2008.

Stop back when you and your friends are 65 so we 80 year-olds can ask "How's that working for ya?"  You may be fine, but I'll bet a lot of of your friends will not be.

Nope, I take my beatings along with every other investor.  No magic to anything I am invested in.  Actually I have moved a lot closer to a balanced fund approach as I transitioned to ER.  I'll likely annuitize a chunk as I get older and if the poop hits the fan in the next few years I will probably resume generating income for a while, but that is about it.

Again, you are tossing 50 years of scholarly research in favor of I am not sure what.  Paranoia?

Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Nords on April 02, 2014, 11:07:55 PM
Even your friend Nords is hedging his bets by keeping the rental and juicing his stock returns by writing options.  Their retirement is likely going to be "overfunded."
Here, let me put my own words in my mouth.

1.  We have a rental property.  We "acquired" it in 2000 by upgrading to our dream home.  (In retrospect, that was the worst period in 15 years to be selling real estate-- but a fantastic time to upgrade.)  We were both on active duty in 2000 and too busy to FSBO our old home in a buyer's market, so we rented it out for a few months while we waited for our lives to settle down and the market to recover.  After eight months our military tenants moved out of our rental and into base housing. 

Then my parents-in-law moved into our rental and stayed there for nearly six years.  Hint for new landlords:  this does not cashflow, and it will not enrich your net worth.

When they finally moved back to the Mainland, we put a great set of (military) tenants in there while we rehabbed the property to put it on the market.  Then my spouse pointed out that it's a very elderly-friendly property (single level, one block from stores & doctor's offices) and that our daughter might someday want to take over our "dream house" (with its kid-friendly neighborhood and great schools) while we geezers could move into the rental to age in place.

Our cash-on-cash return is about 4%, which on Oahu is considered "studly".  Our return is calculated on the money we'd have left after selling the place and paying off the mortgage, minus federal/state taxes and AMT and depreciation recapture.  (Oahu's median price for a single-family home is over $650K and our neighborhood's market rents are about $2900/month.)  Today we're happy to be beating CD rates, but in 2006 our rental property looked pretty sad alongside 6% CDs.

If you can help me craft a spouse-friendly exit strategy for this situation then I'm all eyeballs.  However this was not even a glimmer in our ER planning, and I'm not hedging anything with it.

Of course my attitude is perhaps biased by the fact that I'm currently working on Schedule E.  Or at least that's what I'm supposed to be doing instead of posting here...

2.  I've been writing options since 2010.  I've made $36K (before taxes) and been exercised once.  My last batch of options expired in January and I haven't sold any since then.

The reason we write options is to minimize our perpetual debate about rebalancing.  Our retirement portfolio is over 90% equities in Berkshire Hathaway and three ETFs, all of which have an options market (especially BRK and the small-cap value ETF IJS).  When our asset allocation used to reach the limit of its bands then we'd debate the subject ad nauseum infinitum:  "But it might go up/down some more."  "But we'll pay a lot in taxes."  "But we LIKE that asset!"  "But this is a TERRIBLE time to buy!" and so on.  Now, when our AA reaches a limit, we simply sell a call option or a put option.  We get a little money from the premium and raise a toast to all the reading & studying I did to figure out how to make this work.  If we're exercised, then we're brilliant.  If we're not exercised then we probably sell the same option all over again and keep waiting. 

These days our assets are all sitting near the middle of their bands and there's no reason to rebalance.  I might get a chance to sell some puts on the international value ETF (EFV) or to sell a few calls on BRK, but the options prices suck-- nobody thinks that either asset is moving any further. 

In the last 12 years my military pension has received a cumulative 27% COLA (despite a couple of zeros in that series).  However in the last 12 years we've refinanced our mortgages on our home and our rental and reduced our monthly P&I payments by 40%.  When we bought our "dream home" in 2000 we were thrilled to get a 30-year fixed mortgage at "just" 8%.  Today it's at 3.625% and it won't be paid off until I'm 80 years old.

My pension covers most of our expenses these days, and our portfolio dividends (Dow dividend ETF, DVY) are very nice too.  But we still sell off a few stock or ETF shares every year to replenish our two-year cash stash, and so far we're staying within a 4% SWR.  That's because we've really whittled our expenses down in ER, and partially because we have unexpected cash flow from an unplanned rental property.  If you'd told me in 1999 what our asset allocation and finances would look like in 2014, I would not have believed it.

So, sure, income streams are great-- especially when you're happy to keep slaving away in a cubicle for however much longer it takes to reach that elevated level of the FI game.  Or if you're hard-wired (or hard-taught) to be a landlord.  Or own your business.  Or love being in the military.

But 50 years of history & analysis (or whatever appropriate number of decades) has shown that a 95% probability of success tends to fund 19 out of 20 ERs.  In 1999 I couldn't tell you what our net worth would be today, but I was 95% confident that it'd be positive.  I was right, and by a honkin' big margin of error.  I agree that the 4% SWR might be hard for many investors, and if they're stupid then it's impossible.  But it's also reasonable to give responsible, informed investors a good set of thumbrules and guidelines, especially when they can consult their best anonymous Internet buddies to make sure they're on the right track.

By the way, my friend Brewer helped me figure out how to analyze stocks and where to learn about selling options.  He seems pretty good with bonds, too, and he can even teach you how to build an indexed annuity at a very low cost.  I am eagerly anticipating his "tell all" memoirs about his years of his financial career that he won't talk about.  He's seen enough to be justifiably cynical & paranoid about the financial industry.  DoubleDown is probably not selling anything, but Brewer and I have been posting to ER forums for years and have seen plenty of pitches which started out this way.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: dude on April 03, 2014, 05:57:12 AM
Fifty years of scholarly efforts are interesting, but not reassuring when it comes to converting assets into income that shows up at regular intervals.  After all, haven't we all learned that past performance is not predictive of future results?  Sequence of returns risk is forefront in many peoples' minds because of what we just went through in the last 6 years.  Security is difficult to achieve with these thoughts running through your head.

Plop your assets into a low cost 60/40 balanced fund, don't draw more than 4% inflation adjusted of your starting value, live a long and full life.  I just said it in one sentence which I had to make longer with comments about life because this isn't that complicated.

Agree.  In the 401k world, I think the predominant retirement income vehicles for most will be their 401k and Social Security.  The 4% SWR is a very important tool.  While only a 19-year sample size, I think John Greaney's "Real Life Retiree Investment Returns" annual updates (the last one being 2012; 2013's should be out next month) is very instructive.  Consider the huge swings in the market we've had since 1994 (dot.com bust, 9/11, 2008), including the worst recession since the Great Depression, and yet look how the 4% SWR has fared:

http://www.retireearlyhomepage.com/reallife13.html

I'll take that as pretty ample proof that it works pretty damn well.  For a sequence of returns risk, as I've stated elsewhere, having 2-3 years' worth of living expenses in cash on hand should more than suffice to get one through a market downturn early in retirement (or simply cut expenses until the market rebounds).  Dismissing the 4% SWR -- a heavily researched subject -- out of hand smacks a bit of hubris.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 03, 2014, 08:24:09 AM
Nords:

The MM's retirement is likely to be "overfunded" because their spending rate is so low and they continue to invest a large percentage of their income.  No idea whether yours is.  I'm sorry if that was not clear.

I have nothing but the utmost respect for both you and Brewer12345.  You are two of the most knowledgeable posters on these forums.  I pay close attention to what both of you write.  Your and my "early retirement" investing styles are not dissimilar, except I am just fine with being a landlord and real estate is the bulk of my portfolio.  Real estate is my area of professional expertise, so it comes with the territory.  It might not be appropriate for everyone.  I have refinanced my house several (seems like countless) times since buying it in 1989.  I pulled out equity to buy rentals, but the last refi was to reduce expenses.  Like you, my exit strategy for my house is probate, if for no other reason than my basis (that was rolled from a previous house under the old rules) is so low.

I'm also older than both of you, and I see people every day that have met the "target number" by diligently saving and investing.  Ummmm...now what?  They are not really sure.  You and I have pensions, these folks don't.  They don't have your level of skill and knowledge or your confidence.  They have to rely on the advisors and salespeople that got them to the target.  In the last few years, folks like Fidelity and Vanguard have started selling annuities and giving seminars on retirement income, because good decumulation plans are few and far between.   

The retirees and pre-retirees I know that feel secure are the ones with pensions and/or income producing assets.  The ones that don't have pensions or income producing assets are scared.  They are like some of the folks over at earlyretirement.org, wondering if they have enough because different retirement calculators give different results, and if they should work one more year (or five) to "make sure."  I'm not saying "toss 50 years of research."  I'm saying that 50 years of research is not making folks feel secure, especially in light of recent market gyrations and "newly discovered" sequence of returns risk.

The folks reaching their 60's now are the first generation with a large group having paper asset accounts instead of guaranteed pensions.  Pensions are income "plans," 401k's are not.  So, yeah, I agree with DoubleDown.    An income plan is critical.  That plan is best formulated well before you need it.  And for a lot of folks, that plan should and will include assets other than their paper 401k's.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 03, 2014, 08:41:38 AM
Nothing special about a pension, IMO.  There are any number of insurers panting and drooling to sell you one in the form of a SPIA or other alphabet soup product.  Some of them are even insurers that meet my credit standards.  If you have a pile of assets and want to turn some of them to a stream of payments, it is easily done.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: smalllife on April 03, 2014, 08:47:43 AM
Just posting to follow along, very interesting discussion!
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 03, 2014, 09:09:08 AM
You have a very different perspective.  You have 20 years or more of experience with this.  You have the knowledge and confidence to decide to annuitize and to pick an insurance company.  You understand the product being sold.  Most folks do not.  They have to rely on financial "advisors" and salespeople, most of whom get a commission on these products.  Even Vanguard collects a fee/commission when you buy an annuity from them.

Pensions are black and white, and there are generally not a lot of decisions to be made about them.  The word "pension" means security to most people, even with the occasional Detroit or PBGC disaster.  That's especially true if you are a government employee.  You have a pretty good idea of what you are going to get early on.   Annuities?  Most folks don't understand what they are buying or how to shop.   Add in the long term uncertainty from buying at today's low interest rates, and no one is happy.

For me?  I'd rather take my chances with my income producing assets.  They have served me very well so far.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 03, 2014, 09:15:34 AM
Frankly, squabbling over the value of pensions is a moot point for the under 50 crowd.  Most of us will not have one or will have one that pays a pittance (I am in the latter bucket).  So if you are under 50 and want a pension you will probably have to buy one.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 03, 2014, 09:21:25 AM
I wrote a provocative title, glad it got some discussion! Like I said in the OP, I'm hoping people who are confused about how to turn the 4% SWR into income will benefit from looking at things from another perspective, demystifying the process a bit. When planning my own ER, it would have been anything but useful to have a plan that was simplified down to "withdraw 4%." You might as well have answered my question about how to change my oil with, "just do it."

Thanks AnotherReader for your added voice and perspective, definitely helps convey what I was thinking about.

Although my subject title was provocative, I don't really think the 4% SWR guideline should be tossed. But it's inadequate by itself -- we clearly get a lot of posters on this forum who don't understand how it's supposed to work once you're retired, or what assets go into it (like home equity), and so on. I agree it's a neat motivating tool to help figure out what is "enough", but it's too simple to just say "withdraw 4% each year, and you're safe." How do you withdraw it? By reaping dividends that aren't reinvested? By selling stocks? Then which stocks are sold? You need more information, you need a plan for where your income will come from.

I'm with AnotherReader that I want a more refined plan, where I'm drawing on different asset classes at different times to meet my own needs, and where I feel safe and confident that I'll be covered at all stages of life. I get that that approach might be more complicated than some want to deal with, but I don't see that as much different than any other choice where someone forgoes maximizing efficiency in the name of "convenience." Or some people might not have any trouble sleeping through market ups and downs with an all-paper portfolio, but that's not me.

Maybe looking at it this way helps: By thinking about how you will generate income in retirement (beyond the over-simplified "withdraw x%"), you are forced to think about deeper questions such as your asset allocation, how favorable those assets are for cash flow, risk you are comfortable with, tax implications, potential uneven expenses over your life, etc. That's partly what I mean about forgetting about an SWR, and instead thinking about where your income will come from.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 03, 2014, 09:26:39 AM
That makes sense DD.  Thanks for the explanation.

I think everyone should do those things, even with a simple 4% 60/40 portfolio.

The idea of income streams is incidental to this.  I think re-framing it as "it's all about income" is what confused some of us.  But putting it into a "How will you use the 4% SWR to generate income" as a question makes more sense.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 03, 2014, 09:36:07 AM
*Sigh*

OP, what are you selling?  I feel compelled to ask because this sort of thing is so often the prelude to such.

Now that that is out of the way, I will say that A) it is unwise to throw out 50 years of scholarly efforts on this subject and B) I do not like the income approach because it tends to drive people to do stupid yield chasing.  I have watched a variety of retirement implosions due to various forms of idiot yield chasing (high dividend stocks, highly concentrated junk bond portfolios, various dopey options strategies, Venezuelan Beaver Cheese Futures...).  If you are trying to simplify, beware that those that prefer simple often are simple.

That's funny it would have appeared I was possibly leading up to selling something! That never would have occurred to me. But sir, I for one would like to buy your Venezuelan Beaver Cheese Futures.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: skyrefuge on April 03, 2014, 10:41:42 AM
This post makes no sense to me. "Forget the 4% SWR, or Any SWR - It's All About Income"? That's like saying "forget about miles-per-gallon, it's all about fuel costs!" Huh? 

Yes, of course it's all about income, that's no surprise. But why the heck would we forget about SWR? The whole point of SWR research is to let you know the amount of income that the stock/bond portion of your portfolio can safely generate! Your Step 2 is "Determine what your assets are worth, and what income (if any) they will or can generate for you in retirement". SWR is the very mechanism we use to determine that!

Someone with $1m in cash and a 50-year retirement might think "that can produce $1m/50 = $20k of income for me per year". SWR research tells them, no, that's a bad fucking idea.

Someone with $1m in a stock/bond portfolio who gets $20k per year in dividends/interest might think "that $20k is all I can safely spend per year". SWR research tells them, no, if that's all you're spending, you've oversaved, and spent unnecessary years working.

Yes, if your income sources in retirement are entirely from pensions, Social Security, and annuities, then you can forget about SWR. But that's only because the people managing those income sources for you have calculated the SWR on your behalf! They sure as hell aren't forgetting about it!

In terms of confusing people, I fail to see how reading a couple of paragraphs explaining the mechanism by which to sell assets in retirement is any more complex or difficult than it would be to acquire a real-estate portfolio, pensions, and an ironclad Social Security guarantee.

To me, this whole thread just sounds like another version of "I'm very conservative, and don't believe that the historically-safe WR of 4% will hold going forward." That's totally fine, but don't throw out the very useful SWR research for the rest of us.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: hybrid on April 03, 2014, 12:42:17 PM
This post made a lot of sense to me in that I have not stumbled across a canned calculator that begins to appreciate the financial position we are in. The missus is retiring with a pension in a few years and will also get Social Security in 2-10 years depending on when we take it (hopefully 10).

I am at the point that if I want a pension as well, I need to get back into a state job on the hurry-up so I can get 20 years in by age 60. Not my first choice, but damned near impossible to approximate on a retirement calculator.

Then there is the rental, when we pay both mortgages off, anticipated 401K amounts, do we acquire more rental property, etc. etc.

I keep it as simple as possible on a spreadsheet. X is the amount we expect to come in from all sources. Y are our expected normal expenses. And then I aim high for everything else, because I have no idea what curve balls life may throw at us going forward.

So yes, the idea that you need XYD in assets or some kind of "number" isn't particularly helpful for me. My two biggest concerns are how much cash flow will be coming in from various sources compared to what I can conservatively and reasonably expect to spend in retirement.   
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 03, 2014, 01:43:31 PM
The more I think about it, the more I'm convinced that there isn't likely a prototypical early retiree that will have a steady expenses/income need from now until they die. One obvious breakdown is the "old man vs. young man money" scenario if you're retiring early -- you break up your retirement into phases where you're living largely off taxable accounts, then you start tapping 401k's and IRAs once you're 59.5. I'll bet most people find themselves in situations more complicated than that. I'm not a complicated guy, but I've got at least 6-7 different periods I foresee where my spending or income sources could vary a lot, and I need a plan to accommodate: My wife decides to stop working; putting kids through college; ceasing child support payments to my ex-wife; kids grow up and are out on their own; potentially moving to a low cost area; doing a long travel period; able to start drawing a pension; able to draw social security.

There's no way I could just come up with a safe withdrawal rate from now until I die, and live off that (except of course by saving way more than needed so no matter what expenses come up, I'd have more than enough). I'd also be concerned about really young people naively guessing that their expenses are likely to remain completely steady over their lives, without considering the numerous curveballs life could throw.

Plus, I do not expect my assets to appreciate at the same rates over time. One example is that real estate will appreciate at a rate different than stocks, and it's leveraged. My good ol' spreadsheets have to keep track of how those assets will accumulate and be used separately. Maybe I'm just restating the obvious here and those in the know are saying "Duh." But I've gotten the impression from many of the questions typically posted in this forum that a lot of folks don't get it.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: happy on April 03, 2014, 04:04:08 PM
I love it when the big boys come out and rumble :)  I learn a lot.

Quote
This post made a lot of sense to me in that I have not stumbled across a canned calculator that begins to appreciate the financial position we are in.

I found Todd Tresidder's ultimate retirement calculator financialmentor.com/calculator/retirement-calculator‎ (http://financialmentor.com/calculator/retirement-calculator‎)will cover a lot of variables such as you're describing. The only variable I had difficulty with is that you can only set a single tax rate, which maybe works in US, but Down Under different sources may be taxed differently.  He goes into some detail about the assumptions/methods behind the calculator but I am not geeky enough to critique them. He seems well researched. Happy to be corrected.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: matchewed on April 03, 2014, 05:51:52 PM
The more I think about it, the more I'm convinced that there isn't likely a prototypical early retiree that will have a steady expenses/income need from now until they die. One obvious breakdown is the "old man vs. young man money" scenario if you're retiring early -- you break up your retirement into phases where you're living largely off taxable accounts, then you start tapping 401k's and IRAs once you're 59.5. I'll bet most people find themselves in situations more complicated than that. I'm not a complicated guy, but I've got at least 6-7 different periods I foresee where my spending or income sources could vary a lot, and I need a plan to accommodate: My wife decides to stop working; putting kids through college; ceasing child support payments to my ex-wife; kids grow up and are out on their own; potentially moving to a low cost area; doing a long travel period; able to start drawing a pension; able to draw social security.

There's no way I could just come up with a safe withdrawal rate from now until I die, and live off that (except of course by saving way more than needed so no matter what expenses come up, I'd have more than enough). I'd also be concerned about really young people naively guessing that their expenses are likely to remain completely steady over their lives, without considering the numerous curveballs life could throw.

Plus, I do not expect my assets to appreciate at the same rates over time. One example is that real estate will appreciate at a rate different than stocks, and it's leveraged. My good ol' spreadsheets have to keep track of how those assets will accumulate and be used separately. Maybe I'm just restating the obvious here and those in the know are saying "Duh." But I've gotten the impression from many of the questions typically posted in this forum that a lot of folks don't get it.

I can see what you're saying. But isn't that the eternal YMMV?

When starting people off and someone asks the question "how do I FIRE?" I still think the quick and dirty is appropriate with a caveat of continual education about the matters, so that the quick and dirty becomes something more nuanced and knowledgeable regarding the risks and variables that come with life and planning for FIRE.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: DoubleDown on April 03, 2014, 08:28:33 PM
I can see what you're saying. But isn't that the eternal YMMV?

Maybe. But now that I'm thinking it's probably far more common to have these different phases with different drawdown strategies, the single SWR is appearing more and more irrelevant and ill-advised to me. I mean, no doubt some are comfortable with a simple 60/40 asset allocation and 4% withdrawal strategy forever, and that's great for them. But I'm now thinking that may be more of an exception rather than the rule.

When starting people off and someone asks the question "how do I FIRE?" I still think the quick and dirty is appropriate with a caveat of continual education about the matters, so that the quick and dirty becomes something more nuanced and knowledgeable regarding the risks and variables that come with life and planning for FIRE.

Then I think that the "how do I FIRE" question has not been concisely and sufficiently answered here, at least not since I've been around this site. If it was so straightforward, we wouldn't see so many questions about it. I feel like the quick and dirty answer is too little, and a long explanation tailored to each person's circumstances is too much, so maybe there's a Goldilocks answer somewhere in the middle. That's why I'm suggesting that in addition to paying attention to the Trinity study, that the primary answer is to figure out how you will meet your income needs. Once someone does that, it becomes a lot clearer if they're adequately prepared (or even able) to FIRE.

In his blog posts, MMM described the Trinity study and the 4% SWR which is all great -- but then we see he's not really following that model at all. Rather, his income primarily comes from rental property, plus some side work, and now lots of unexpected-at-the-time blog income while his paper assets grow even larger. I don't mean to suggest he pulled a fast one or anything -- he had an excellent strategy for ER, and described it in detail. It is anything but a 4% withdrawal strategy though. His spending has remained constant apparently. I guess he does not foresee any significant change in that, like having any more kids, moving to a lower cost of living area, and so on.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 03, 2014, 10:05:29 PM
Then I think that the "how do I FIRE" question has not been concisely and sufficiently answered here, at least not since I've been around this site. If it was so straightforward, we wouldn't see so many questions about it.

Are you kidding?  We see questions about pay off the mortgage vs. invest, and every angle of that has been discussed a million ways and times.  How about the question "how do I access funds from a retirement account"?  That's been fully answered multiple times.  We still see it, a lot.

People don't read or search.  Doesn't matter how sufficiently or concisely it's been answered, you'll still see lots of questions about it.  Welcome to the internet.

The problem is you are trying to add complications people aren't ready for.  One needs to start with understanding the Trinity study, and the 4% SWR, and then progress to an individualized plan.

If they try to jump to the end before understanding and knowledge, they'll fuck it up.  Like people who just want to know what to invest in, without wanting to bother figuring out an IPS or AA.  And fucking up your ER plan is a bad, bad idea.

Simple at first ("Withdraw 4% annually from a 60/40 portfolio") then customize later as one learns.  Anyone who has been around ER forums for awhile will run across all the strategies.

Buckets of money, for example, I'm sure you're familiar with?  That's a semi-popular one that helps explain and simplify the part you think people are confused on.  People like Brewer probably don't see the point.

But I get where you're going with it.  I just think you're going to have people jumping the gun in your efforts to help, because they don't know what you know.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: okonumiyaki on April 04, 2014, 03:06:50 AM
Yep, I quite like the bucket of money idea because we hope to move to Indonesia, so have to deal with currency risk as well.

Current decumulation plan is:

12.5% of assets in laddered IDR government bonds, 1/5 maturing each year.
25% in international bond ETF
Rest in equities. (most in ETF, but allocation for self invested play money as well)

"refill" the bond ladder every year with 2.5% of assets on a 5 year bond during rebalancing.

Possibility of buying shares in decent local gas stations though, which might alter things

Basically a 3% SWR as will use some USD dividend income for foreign travel etc.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Fastfwd on April 04, 2014, 06:24:21 AM
It is definitely a complex calculations with a lot of unknowns. I myself prefer firecalc to cfiresim but they both lack a lot of variables I'd like to use.
I definitely prefer the monte-carlo or historical period approach to the gradual average historical return calculations so that makes firecalc much better than any financial planner
tool.

What financial planners have that is lacking from firecalc:
Calculations based on tax sheltered and non-sheltered accounts. Having 1mil$ that you have to pay taxes on at withdrawal is very different from 1mil$ in a normal account. Here the max rate can go above 50% so that's actually less than 500k$ if I withdraw it all at once.
Gov pension and the impact of starting to withdraw early or late instead of 67.

I do my planning mostly with firecalc but I also have a few of my own spreadsheets I play with. I don't want to go into real estate or plan for part time work once I declare myself "free" so the 4% rule very much applies to me. Difference is that I plan to adjust my spending and retirement date to the situation; I won't retire on a year where the stock market did 20%+ and I just then barely made my number. I will spend less if the market does badly in the first few years.

And then there's the expense planning. If someone had asked me 5 years ago what I would need to spend money on in 2014 I would have been seriously wrong; I expect the same trying to guess what I will be doing with my life at 50,60 or 70+
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: brewer12345 on April 04, 2014, 08:01:53 AM
Buckets of money, for example, I'm sure you're familiar with?  That's a semi-popular one that helps explain and simplify the part you think people are confused on.  People like Brewer probably don't see the point.

I don't see the point in it and view as a behaviral finance trap.  The shyster who came up with it also got nailed for faking the data/research that supposedly showed buckets as a good/valid withdrawal scheme.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 04, 2014, 08:03:20 AM
I myself prefer firecalc to cfiresim

Huh?  Why?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Fastfwd on April 04, 2014, 08:07:30 AM
I myself prefer firecalc to cfiresim

Huh?  Why?

I think it's mostly presentation. They both seem to do about the same thing and give similar results. I just find that firecalc is easier to follow maybe because I used this one first.
- Portfolio value today
- Added to portfolio from now to x years later
- Withdrawn from portfolio x years later to life expectancy
- Some gov pension thrown in at year y
Both take those kind of numbers but I prefer how firecalc does it. Also I had fun playing with options in the spending models(Bernicke and % of portfolio)

Is there something I am missing that cfiresim does better?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 04, 2014, 08:18:44 AM
Is there something I am missing that cfiresim does better?

Two off the top of my head: more up to date with data, I like the individual lines to trace the paths, saving simulations (though you can do this with a paid FIRECalc account), flexible spending/saving inputs, etc..  Essentially cFIREsim does everything FIRECalc does but also adds more.  Plus the creator actually takes requests and interacts with people and improves it.  FIRECalc stagnated with bugs for years. (I'm still not sure the bond issue is fixed.)

I'm sure bo_knows, the creator of cFIREsim (you can message him on these forums or contact him through the cfiresim site) can add more to the differences/enhancements list as well.

Buckets of money, for example, I'm sure you're familiar with?  That's a semi-popular one that helps explain and simplify the part you think people are confused on.  People like Brewer probably don't see the point.

I don't see the point in it and view as a behaviral finance trap.  The shyster who came up with it also got nailed for faking the data/research that supposedly showed buckets as a good/valid withdrawal scheme.

I agree, but some people need decide to think of it in a different way.  My point wasn't to advocate for the buckets strategy, but to point out that there are numerous methods like this floating around the ER community.  Starting with a basic "4% of total assets" withdrawal strategy is good to introduce the topic, and then more strategies will be found and discussed and learned as one dives into ER and can choose which strategy is right for them.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: matchewed on April 04, 2014, 09:04:52 AM
I can see what you're saying. But isn't that the eternal YMMV?

Maybe. But now that I'm thinking it's probably far more common to have these different phases with different drawdown strategies, the single SWR is appearing more and more irrelevant and ill-advised to me. I mean, no doubt some are comfortable with a simple 60/40 asset allocation and 4% withdrawal strategy forever, and that's great for them. But I'm now thinking that may be more of an exception rather than the rule.

Right but isn't that the nuance that I spoke about? As people become more educated in these matters it is easy to see how inadequate the 4% SWR is when framed as "Just hit 25x expenses and you're FIRE." But for those who are walking into this telling them that it is inadequate from the get go and then throwing them into the deep end of the financial pool is a great way to discourage them from trying something that is actually doable and has a foundation in the 4% SWR and the Trinity study. And that's all those things really are; foundations. You don't start figuring out how to build a house with calculating load bearing walls or whatever (I've obviously never built a house). You start by knowing how to use a hammer, how to measure and cut...etc.

When starting people off and someone asks the question "how do I FIRE?" I still think the quick and dirty is appropriate with a caveat of continual education about the matters, so that the quick and dirty becomes something more nuanced and knowledgeable regarding the risks and variables that come with life and planning for FIRE.

Then I think that the "how do I FIRE" question has not been concisely and sufficiently answered here, at least not since I've been around this site. If it was so straightforward, we wouldn't see so many questions about it. I feel like the quick and dirty answer is too little, and a long explanation tailored to each person's circumstances is too much, so maybe there's a Goldilocks answer somewhere in the middle. That's why I'm suggesting that in addition to paying attention to the Trinity study, that the primary answer is to figure out how you will meet your income needs. Once someone does that, it becomes a lot clearer if they're adequately prepared (or even able) to FIRE.

In his blog posts, MMM described the Trinity study and the 4% SWR which is all great -- but then we see he's not really following that model at all. Rather, his income primarily comes from rental property, plus some side work, and now lots of unexpected-at-the-time blog income while his paper assets grow even larger. I don't mean to suggest he pulled a fast one or anything -- he had an excellent strategy for ER, and described it in detail. It is anything but a 4% withdrawal strategy though. His spending has remained constant apparently. I guess he does not foresee any significant change in that, like having any more kids, moving to a lower cost of living area, and so on.

What I said above applies to your first paragraph here as well. Just saying you need enough income to meet your expenses and you're FIRE is just as overly simplistic as 25x expenses or the SWR. All they happen to be are simple rules of thumb so that people can start to wrap their heads around FIRE and get out of the "exploding volcano of wastefulness" lifestyle; buying your future and all that.

As for your second paragraph -
Why does it matter if MMM is doing specifically the 4% SWR strategy or not? Did Jacob over at ERE? How about the folks at earlyretirement.org did they all have to be using that strategy in order to discuss it? MMM has laid out an initial foundation for people to grasp and begin a path for FIRE. I'd  venture a guess that this forum is for or represents a middle range of that path. Some individuals are further down it, some are still at that beginning, that is why it is important to keep discussing these basics even as repetitive as it can get for those further down the path. Or how "useless" (maybe inadequate?) the basics are for those further down the path.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 04, 2014, 09:17:42 AM
As I see it, the income and SWR methods are joined at the hip. They are two viewpoints that are mathematically equivalent, or rather the SWR picture is a simple corollary to the income method.

I'm in a situation like DoubleDown in that my cost structure in the future will have almost no resemblance to what it is now. In a case like that, you need to

1) project out your costs for each year of your life

2) use a present value method to calculate how much money in a lump sum today you need to generate that income.

If you've never heard of present value, you should really look it up. It's not too difficult and should really be the minimum knowledge you should have if you're going to embark on an out-of-the-mainstream project like extremely early retirement. All you do is take each year's desired cash flow and multiply by 1/(1+4%)^n, where n is the number of years away that cash flow is. Then you sum up these discounted cash flows and you end up with the lump sum amount of cash you need today to get those cash flows. Why the 4%? You can put whatever rate you want in there, but it should be the rate of return you expect on your assets going forward. In this case I'm assuming that we are using inflation adjusted cash flows, so I'm using an inflation adjusted return as well. I'm assuming you can get a 4% real rate of return.

The magic of mathematics being what it is, if you have constant cash flows going out forever, this whole procedure simply says the lump sum amount is equal to the yearly cash flow divided by the discount rate (4%). The proof is not trivial, but can be done by a good math student.

In other words, using an SWR of 4% is mathematically the same as using DoubleDown's income method, assuming constant cash flows and a 4% real return on investment.

The income method is just more flexible in that you can use varying cash flows over time, and in principle could use different discount rates at different times and so on).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: oldtoyota on April 04, 2014, 09:40:54 AM
or.....have a pre-determined asset allocation and stick with it. For example, if by the time you retire you have 1M liquid asset and your yearly budget is 35k. Then an asset allocation that would work could be :

3.5% cash
30% Bond
66.5% Stock

if your investments make some money during the year and assets increases to 1.05M, rebalance at the beginning of the year and take out the cash.

if your invesetment loses money during the year and assets drops to 0.95M, you do the reverse. It'd be wise to have a nice cushion (20%?) if you use this method, that's what we are planning to do.

There are many ways to do this, i feel they are all more or less the same.

I think that's a sound approach too, but personally I'm too much of a wuss to have an all-paper portfolio. I think I would not enjoy my freedom if we were going through a 2- or 3-year+ market downturn, and I'm selling stocks at bargain basement prices in order to convert to cash to live off.

My plan to deal with that would be to have enough cash to live on so I don't have to withdraw cash during inopportune times. I have a multi-layered approach to this retirement business. My first "layer" is cash and income. The second is easy-to-get investments like a taxable IRA. The third is the money I'll use later down the line, if needed, and which is not as easy to get or has age restrictions.



Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: oldtoyota on April 04, 2014, 09:42:20 AM
An alternative to the 4% SWR (annual expenses x 25) is the "living off the dividends" approach-- which is typically estimated at 3% or 33x.  If you want to be ridiculously conservative then you'd use the S&P500 dividend rate, which puts you up into 40x-50x territory.


This is a question I've thought about and need to think about more as I get closer to FI--and one that I find challenging to forecast.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 04, 2014, 12:08:55 PM
What problem does living off dividends solve? It sure doesn't give you a stable income or one that is indexed to inflation.  I guess it does remove your "choice" in spending ability. The guys in corporate finance will decide every year how much you get to spend.

An alternative to the 4% SWR (annual expenses x 25) is the "living off the dividends" approach-- which is typically estimated at 3% or 33x.  If you want to be ridiculously conservative then you'd use the S&P500 dividend rate, which puts you up into 40x-50x territory.


This is a question I've thought about and need to think about more as I get closer to FI--and one that I find challenging to forecast.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 04, 2014, 12:26:58 PM
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What problem does living off of dividends solve?

It solves the sequence of returns risk, roughly. If you're holding a non-dividend paying stock, and it's price gets cut in half, you're forced to sell at those low prices to pay your living expenses. So you just had to sell twice as many shares as you had budgeted for. Sure, the price might come back, but that's not much consolation when you're holding fewer shares than you were planning on. The stock might later even go higher, but the problem is that it doesn't cancel. You can show that volatility reduces your average return when you're taking money out for living. Up and down price movements don't have a symmetric effect.

If you're paid dividends then you don't sell shares at the bottom and at the end of the day the volatility doesn't matter.

Of course, living off dividends giveth and it taketh away. You expect stock prices to rise more than inflation, and the cost of that is a low dividend rate (2% today). So you have to save more money to live off of it.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 04, 2014, 12:38:07 PM
If you're holding a non-dividend paying stock, and it's price gets cut in half, you're forced to sell at those low prices to pay your living expenses.
If you're holding a dividend-paying stock, and the dividend gets cut in half, you're forced to sell some of the stock to make up the difference - and the price when you sell will be low because the dividend just got cut in half.

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If you're paid dividends then you don't sell shares at the bottom and at the end of the day the volatility doesn't matter.
Functionally, you do. Collecting a dividend is equivalent to selling that amount of the stock, because your holdings in that stock go down by (the market's expected value of) the dividend received. If the stock price is low that day, then your dividend is equivalent to "selling low".

If you sell 4% of a stock every year, it's totally equivalent to the stock paying you a 4% dividend every year (differing tax treatments of dividends and capital gains aside).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 04, 2014, 01:06:31 PM
If you're holding a non-dividend paying stock, and it's price gets cut in half, you're forced to sell at those low prices to pay your living expenses.
If you're holding a dividend-paying stock, and the dividend gets cut in half, you're forced to sell some of the stock to make up the difference - and the price when you sell will be low because the dividend just got cut in half.

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If you're paid dividends then you don't sell shares at the bottom and at the end of the day the volatility doesn't matter.
Functionally, you do. Collecting a dividend is equivalent to selling that amount of the stock, because your holdings in that stock go down by (the market's expected value of) the dividend received. If the stock price is low that day, then your dividend is equivalent to "selling low".

If you sell 4% of a stock every year, it's totally equivalent to the stock paying you a 4% dividend every year (differing tax treatments of dividends and capital gains aside).

Thank you for being someone who understands math wf2.  I appreciate your posts (from the one in the "bet 50k on red thread" and a bunch since then, including this one).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 04, 2014, 01:11:10 PM
They are not 100% linked but that is the general problem with divs. It is the  33x portfolio size instead of 25x is what is making it safer. Not the payout in divs. The solution to market volatility isn't dividends. It is that bonds and cash portion of your portfolio that makes you sell  high and buy low at the cost of a some return.


If you're holding a non-dividend paying stock, and it's price gets cut in half, you're forced to sell at those low prices to pay your living expenses.
If you're holding a dividend-paying stock, and the dividend gets cut in half, you're forced to sell some of the stock to make up the difference - and the price when you sell will be low because the dividend just got cut in half.

Quote
If you're paid dividends then you don't sell shares at the bottom and at the end of the day the volatility doesn't matter.
Functionally, you do. Collecting a dividend is equivalent to selling that amount of the stock, because your holdings in that stock go down by (the market's expected value of) the dividend received. If the stock price is low that day, then your dividend is equivalent to "selling low".

If you sell 4% of a stock every year, it's totally equivalent to the stock paying you a 4% dividend every year (differing tax treatments of dividends and capital gains aside).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 04, 2014, 05:12:34 PM
If you're holding a non-dividend paying stock, and it's price gets cut in half, you're forced to sell at those low prices to pay your living expenses.
If you're holding a dividend-paying stock, and the dividend gets cut in half, you're forced to sell some of the stock to make up the difference - and the price when you sell will be low because the dividend just got cut in half.

True, which is why I said it only "roughly" solves it. But it does reduce it quite a bit. Dividends are far more stable than stock prices, and you have to sell less stock if you also received a dividend. I don't have the numbers in front of me, but if memory serves, during the last financial crisis, dividends on the S&P got cut by about 20% and recovered quickly after a couple years. During the dreaded 1970s, inflation eroded dividends by about 20% of their inflation-adjusted peak and stayed low for probably a decade. That sucks, but if you're living off dividends and you tighten your belt a bit, you can survive without going to plan B (going back to work). Once the market recovers, you're back in business and didn't take a permanent hit to your wealth, unlike what happens when you're forced to sell stock at fire sale prices to live.

But that brings us to your second point...
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If you're paid dividends then you don't sell shares at the bottom and at the end of the day the volatility doesn't matter.
Functionally, you do. Collecting a dividend is equivalent to selling that amount of the stock, because your holdings in that stock go down by (the market's expected value of) the dividend received. If the stock price is low that day, then your dividend is equivalent to "selling low".

If you sell 4% of a stock every year, it's totally equivalent to the stock paying you a 4% dividend every year (differing tax treatments of dividends and capital gains aside).

I have to disagree, but you're using a pretty clever argument that forces me to nerd out on finance theory below.

Take a thought experiment with two different scenarios:

(1) You own 1 million shares of $1 stock that doesn't pay dividends. In other words $1 million dollars. You need $40k to survive. The stock takes a drastic 80% drop. Now it's only $0.20 per share. You need $40k to survive, so you are forced to sell  200,000 shares to survive. You only have 800k shares left. Then the stock market recovers to its old mood and the stock is trading for $1 again. You only have $800k, even though the "average return" was 0% and you only took out $40k. This is how portfolios often fail in firecalc simulations, btw.

(2) You own 1 million shares of $1 stock that pays $0.04 in dividends (4%). Again, $1 million. And again, you need $40k to survive. The stock takes a drastic 80% drop. But luckily, since it's paying a dividend of $0.04 per share, you get paid $40k, and you didn't need to sell anything. The market recovers to its old mood, and the stock is trading for $1 again (I know you object to this. See below.) You now have $1 million and you got your $40k living expenses paid for.

Ok, nerds only from here on.

Ok, I think your point is that if the stock paid a dividend back when it was $0.20 per share, then its price will drop by $0.04, so it will only be trading at $0.16. Then when the market recovers, all the stocks see a five-fold increase, so it's now trading at $0.80 and you only have $800k again.

Very clever, but let me explain why I think it's not quite right. It's true that stocks should drop by their dividend amount when it's paid, but there's more to the story than that. They also rise (slowly) before the dividend is paid.

Take an idealized company that is perfectly stable and profitable forever. Its profits never rise and never fall. Constant forever. It sells for $1 a share, and pays a $0.04 dividend. It's true that when a dividend is paid, the share price drops to $0.96. But clearly it can't keep doing this forever or in 25 years the stock price will be zero, even though it's a perfectly profitable company paying a $0.04 dividend! In this case, this idealized company stock is essentially a bond, and its price (in a rational, efficient market) would exhibit the same saw-tooth behavior that the dirty price (http://www.bogleheads.org/wiki/Bond_pricing#Dirty_price_vs._clean_price) of a bond has. It falls to 0.96, then slowly rises back to $1.00 and so on forever.

So, to get all theoretical, what should happen in our scenario (2) is this: When the non-dividend-paying stock falls to $0.20, the dividend-paying stock doesn't fall as much because part of the price is the imminent dividend payment. Instead it falls to roughly 0.232. Then it pays its dividend, and the new price is 0.192. Then the market increases 5-fold, and the new price is 0.96. Then throughout the rest of the year the price slowly recovers to $1.00 as before. Ugly, I know. But if you think about it, it makes sense. The market totally recovered to where it was before, with the same expectations that it had before the crash. The market knew the stock was going to pay a dividend. Why would people value the company lower just because it paid its dividend when the price was low?


Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 04, 2014, 05:35:01 PM
Take a thought experiment with two different scenarios:

(1) You own 1 million shares of $1 stock that doesn't pay dividends. In other words $1 million dollars. You need $40k to survive. The stock takes a drastic 80% drop. Now it's only $0.20 per share. You need $40k to survive, so you are forced to sell  200,000 shares to survive. You only have 800k shares left. Then the stock market recovers to its old mood and the stock is trading for $1 again. You only have $800k, even though the "average return" was 0% and you only took out $40k. This is how portfolios often fail in firecalc simulations, btw.

(2) You own 1 million shares of $1 stock that pays $0.04 in dividends (4%). Again, $1 million. And again, you need $40k to survive. The stock takes a drastic 80% drop. But luckily, since it's paying a dividend of $0.04 per share, you get paid $40k, and you didn't need to sell anything. The market recovers to its old mood, and the stock is trading for $1 again (I know you object to this. See below.) You now have $1 million and you got your $40k living expenses paid for.
You're assuming that after an 80% drop, stock (2) still pays a $0.04 dividend. Obviously, if the assumption is that dividends never go down even in drastic circumstances, then the conclusion will be that dividends are safe income in perpetuity.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 04, 2014, 06:05:02 PM
Take a thought experiment with two different scenarios:

(1) You own 1 million shares of $1 stock that doesn't pay dividends. In other words $1 million dollars. You need $40k to survive. The stock takes a drastic 80% drop. Now it's only $0.20 per share. You need $40k to survive, so you are forced to sell  200,000 shares to survive. You only have 800k shares left. Then the stock market recovers to its old mood and the stock is trading for $1 again. You only have $800k, even though the "average return" was 0% and you only took out $40k. This is how portfolios often fail in firecalc simulations, btw.

(2) You own 1 million shares of $1 stock that pays $0.04 in dividends (4%). Again, $1 million. And again, you need $40k to survive. The stock takes a drastic 80% drop. But luckily, since it's paying a dividend of $0.04 per share, you get paid $40k, and you didn't need to sell anything. The market recovers to its old mood, and the stock is trading for $1 again (I know you object to this. See below.) You now have $1 million and you got your $40k living expenses paid for.
You're assuming that after an 80% drop, stock (2) still pays a $0.04 dividend. Obviously, if the assumption is that dividends never go down even in drastic circumstances, then the conclusion will be that dividends are safe income in perpetuity.

Fair enough. But even if the dividend gets cut in half (which is worse than what happened to the S&P during the Great Depression), you'd still only need to make up for $20k instead of $40k, which would mean selling 100k shares, which once the market recovered would be worth $900k instead of $800k, which is how much you'd be left with from a non-dividend-paying stock.

I'm not saying that living only off of dividends, or switching your whole portfolio to high-yield dividend paying stocks is the best move, I'm only trying to show that there is a real effect here. Dividends really can get rid of much of the bad effects of stock volatility. Reaching for yield and buying cruddy companies just to get a high dividend, though, will probably lead to sorrow...

Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 04, 2014, 06:56:12 PM
I have seen various numbers for the great depression ranging from 20% to 70%. I think it depends on what subset of the market (20 best div stocks, s&p 500, everything) you are measuring.

The unmentioned thing is what is the rate of return of dividend stocks versus non dividend. I have seen a ton of studies on it and it comes down to it depends. Against the general market, div stocks slightly outperform. BUT the studies also suggest that is strictly because of a value bias. You normalize the value bias and high dividend stocks underperform by a couple of percent.

Take a thought experiment with two different scenarios:

(1) You own 1 million shares of $1 stock that doesn't pay dividends. In other words $1 million dollars. You need $40k to survive. The stock takes a drastic 80% drop. Now it's only $0.20 per share. You need $40k to survive, so you are forced to sell  200,000 shares to survive. You only have 800k shares left. Then the stock market recovers to its old mood and the stock is trading for $1 again. You only have $800k, even though the "average return" was 0% and you only took out $40k. This is how portfolios often fail in firecalc simulations, btw.

(2) You own 1 million shares of $1 stock that pays $0.04 in dividends (4%). Again, $1 million. And again, you need $40k to survive. The stock takes a drastic 80% drop. But luckily, since it's paying a dividend of $0.04 per share, you get paid $40k, and you didn't need to sell anything. The market recovers to its old mood, and the stock is trading for $1 again (I know you object to this. See below.) You now have $1 million and you got your $40k living expenses paid for.
You're assuming that after an 80% drop, stock (2) still pays a $0.04 dividend. Obviously, if the assumption is that dividends never go down even in drastic circumstances, then the conclusion will be that dividends are safe income in perpetuity.

Fair enough. But even if the dividend gets cut in half (which is worse than what happened to the S&P during the Great Depression), you'd still only need to make up for $20k instead of $40k, which would mean selling 100k shares, which once the market recovered would be worth $900k instead of $800k, which is how much you'd be left with from a non-dividend-paying stock.

I'm not saying that living only off of dividends, or switching your whole portfolio to high-yield dividend paying stocks is the best move, I'm only trying to show that there is a real effect here. Dividends really can get rid of much of the bad effects of stock volatility. Reaching for yield and buying cruddy companies just to get a high dividend, though, will probably lead to sorrow...
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 04, 2014, 07:02:08 PM
I'm only trying to show that there is a real effect here.
There only appears to be a real effect when you make the assumption that profits paid out as dividends are more reliable than profits used to buy back stock. A dividend payout reduces your holding in the stock by the amount of the dividend (well, the market's expectation of the dividend, but this is more uncertainty, not less) and credits that much to your cash account. This is the same effect as if you had chosen to sell that amount of stock; in effect, the company is buying some stock back from you at the spot price. If the company just used the same money to buy stock back from the market, then the only difference really is that it's up to you how much you will sell them for cash. Reinvesting the dividend is equivalent to choosing to sell none.

Any "imagine two stocks both crash 80%, let's see what happens" hypotheticals which show a difference, are either miscalculated, or hiding an additional assumption. In this case you assume stock (2) is just about to pay out its dividend and then crashes 80%; the dividend paid will be $0.02, but the market expected the dividend to be $0.04, so the price will drop by $0.04, not by $0.02, and your holdings in the company will be smaller because of that. Also, you gave stock (2) an extra year to go from $0.96 to $1 again, but left stock (1) at it's immediate recovery price of $1.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Nords on April 04, 2014, 10:44:50 PM
Then I think that the "how do I FIRE" question has not been concisely and sufficiently answered here, at least not since I've been around this site. If it was so straightforward, we wouldn't see so many questions about it.
Buckets of money, for example, I'm sure you're familiar with?  That's a semi-popular one that helps explain and simplify the part you think people are confused on.  People like Brewer probably don't see the point.
I wonder where Ray Lucia is these days.  What an idiot.

An interesting and controversial side effect of the "buckets of money" strategy was that it led to a rising equity asset allocation in retirement, because people were busy emptying buckets before they refilled them.  Then more rebalancing techniques were piled on top of the original buckets idea in order to avoid a high-equity allocation for (hypothetically) aged retirees of declining cognition.  It seemed to get awfully complicated.

Now Kitces & Pfau are beginning to show that a "rising equity glide slope" in retirement might be a good thing.  In their case, however, I'm pretty sure that it's based on years of peer-reviewed research & analysis.  Maybe Lucia could license it from them...
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 04, 2014, 11:03:59 PM
Ol' Ray still has a radio show.  He's promoting gold, self help legal forms, and a bunch of questionable stuff on the hour that's broadcast locally on the "business" radio station.  His son is doing wealth management and is big on annuities.  He's on during the next hour, along with a couple of Ray's pals.  Ray's handing off the torch I guess.

Of course, we are practicing the BOM strategy by keeping enough cash to fund a couple of years of expenses beyond the pensions....
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 05, 2014, 01:41:56 PM
I'm only trying to show that there is a real effect here.
A dividend payout reduces your holding in the stock by the amount of the dividend (well, the market's expectation of the dividend, but this is more uncertainty, not less) and credits that much to your cash account. This is the same effect as if you had chosen to sell that amount of stock;
Except that if you were paid a dividend, you own the same fraction of the company that you owned before, but if you sell the stock, you get cash, but own less of the company.

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in effect, the company is buying some stock back from you at the spot price. If the company just used the same money to buy stock back from the market, then the only difference really is that it's up to you how much you will sell them for cash. Reinvesting the dividend is equivalent to choosing to sell none.

Interesting way to look at it, and I think I agree here. If you sell 4% of your stock, and the company simultaneously buys back 4% of its stock, I think I agree that's equivalent to getting a 4% dividend. In that case, you maintain the same fractional ownership of the company, you have 4% of your holdings in cash now, and the company has 4% of its market cap less in cash. Same as a dividend. 

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Any "imagine two stocks both crash 80%, let's see what happens" hypotheticals which show a difference, are either miscalculated, or hiding an additional assumption. In this case you assume stock (2) is just about to pay out its dividend and then crashes 80%; the dividend paid will be $0.02, but the market expected the dividend to be $0.04, so the price will drop by $0.04, not by $0.02, and your holdings in the company will be smaller because of that.
 Also, you gave stock (2) an extra year to go from $0.96 to $1 again, but left stock (1) at it's immediate recovery price of $1.

I'll agree that if they cut their dividend from 0.04 to 0.02, then when they make that announcement, the price will drop by 0.02, then on the ex-dividend date it will drop by another 0.02. So a total of 0.04.

And yes, I simplified things by giving the dividend stock a year to recover. It gets a little wishy-washy to get into this kind argument about what the stock price should be theoretically in a year, but if we want an apples-to-apples comparison, we have to make an assumption about the average growth of the two stocks. Say they both give total returns of 7%, so that the first one grows 7% a year and the second grows 3% a year (and pays 4%). Then in a year the first stock is 1.07, but you only have 800k shares. The second is 1.03 and you have all 1 million shares. The second one still ends up better.

But all this talk of exact prices obscures the main point, which is: In case (1), your results depend on the path that prices take during your retirement, because you're constantly selling stock at those prices, but in case (2), your results are path-independent, as long as the dividend doesn't get cut (or at least as long as your living expenses are less than the newly cut dividend).

There seem to be two main objections:

a) Dividends tend to get cut in crashes. Of course, if your dividend is cut, you're worse off. And if the dividend is stopped altogether, you're in the same boat as the non-dividend holding guy. But dividends don't get cut all that often. Only in extreme cases, and even then in a diversified portfolio they don't get stopped completely. The cuts are typically smaller than the price drops. And the rest of the time, the the stock price doesn't matter at all.

b) Non-dividend payers could buy back stock, and if you simultaneously sell an equal percentage of stock, you can simulate dividends. True, and if all your companies always opportunistically buy back stock at rock bottom prices, you'll have great returns. But most don't, so you can't really bank on that. I mean, if you own the S&P index, how are you going to know how much stock you need to sell to balance out share repurchases in order to maintain the same proportionate ownership?

Again, I'm not advocating anything for your portfolio. I personally am more or less indifferent to dividends when I'm buying stock for now. (If it pays large dividends I put it in my tax-advantaged account.) But the question was what is the point of living off dividends, and I think people dismiss it too easily without realizing that the strategy really can mellow out volatility.

Let me put it more starkly. If you did a simulation of early retirees where you had two different scenarios, one with an average 7% annual price appreciation and the other with 3% price appreciation and 4% dividend yield. And both had the same volatility (say 15% annualized volatility). And both had the same withdrawal rate, the first one would have a higher failure rate. There would be some scenarios where the market tanks and stays down for 10 years and the retiree just sells off all his stock.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: MDM on April 05, 2014, 03:03:02 PM
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Quote
in effect, the company is buying some stock back from you at the spot price. If the company just used the same money to buy stock back from the market, then the only difference really is that it's up to you how much you will sell them for cash. Reinvesting the dividend is equivalent to choosing to sell none.

Interesting way to look at it, and I think I agree here. If you sell 4% of your stock, and the company simultaneously buys back 4% of its stock, I think I agree that's equivalent to getting a 4% dividend. In that case, you maintain the same fractional ownership of the company, you have 4% of your holdings in cash now, and the company has 4% of its market cap less in cash. Same as a dividend. 
It's not quite equivalent.  E.g., assume you own 100 shares and the rest of the world owns 100 shares, so you own 50%.  You sell 4 shares that the company buys.  Now you own 96/196 = 49%.  Don't know how that affects the rest of the discussion.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 05, 2014, 03:34:06 PM
Quote
Quote
in effect, the company is buying some stock back from you at the spot price. If the company just used the same money to buy stock back from the market, then the only difference really is that it's up to you how much you will sell them for cash. Reinvesting the dividend is equivalent to choosing to sell none.

Interesting way to look at it, and I think I agree here. If you sell 4% of your stock, and the company simultaneously buys back 4% of its stock, I think I agree that's equivalent to getting a 4% dividend. In that case, you maintain the same fractional ownership of the company, you have 4% of your holdings in cash now, and the company has 4% of its market cap less in cash. Same as a dividend. 
It's not quite equivalent.  E.g., assume you own 100 shares and the rest of the world owns 100 shares, so you own 50%.  You sell 4 shares that the company buys.  Now you own 96/196 = 49%.  Don't know how that affects the rest of the discussion.

Yeah, I was assuming the company bought back 4% of its entire market cap. So they buy back 8 shares (and you sell 4, so they buy another 4 from the world). Then you own 96/192. This just emphasizes how hard this trick is. You don't have the freedom to just sell as much as you want and call it a "dividend". The percentage of your holdings that you sell has to equal the percentage of the market cap that the company is repurchasing. And you have to do it at the same average price as them. It's interesting, but not really practical.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 05, 2014, 03:48:15 PM
I think the "percentage of the shares owned by you" is a red herring, since you don't really have control over that anyway. If other people sell their shares back to the company, your percentage goes up, and if the company issues more shares, your percentage goes down. Stock (1), which pays no dividend, has the company using their profits to buy back shares at the spot price (instead of using the same profits to pay a dividend), so if you sell the same amount as what the dividend would be, then you meet this criteria:
Quote
The percentage of your holdings that you sell has to equal the percentage of the market cap that the company is repurchasing. And you have to do it at the same average price as them.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: steveo on April 05, 2014, 04:01:20 PM
Most people saving for ER are not very interested in continuing to work, so they might find the 4% SWR much more compelling.

I prefer the 4% SWR based on this point. I'm interested in quitting work not working till I get to some state where I 100% confident the money will never run out.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 05, 2014, 05:45:45 PM
Most people saving for ER are not very interested in continuing to work, so they might find the 4% SWR much more compelling.

I prefer the 4% SWR based on this point. I'm interested in quitting work not working till I get to some state where I 100% confident the money will never run out.

Doubly true, since there's no such thing as 100% sure.  :)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: steveo on April 05, 2014, 08:19:55 PM
Most people saving for ER are not very interested in continuing to work, so they might find the 4% SWR much more compelling.

I prefer the 4% SWR based on this point. I'm interested in quitting work not working till I get to some state where I 100% confident the money will never run out.

Doubly true, since there's no such thing as 100% sure.  :)

Definitely. To me the 4% rule is a reasonable rule to base being FI on and therefore being able to retire. I think we all will utilise different asset allocations that each of us will feel safe with. Some people will probably be 100% stocks whereas others 100% bonds. Some will own their house or have rental properties.

I will personally own my own house, not count that as part of my total assets and have a high equity allocation excluding my own house. I also have 3 kids so I figure my spending will decrease not increase over the course of my retirement so 25x my current spending to me is fine. I consider myself having FU level of savings when my assets are at less than current spending 25x level but at myself and my wife's expected 25x spending level. Once I reach FU level I'm ready to start looking towards actually retiring.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 05, 2014, 08:55:59 PM
If they have the same return, they will have the same failure rate if you take the same money out (there is a bit of hand waving as dividends tend to trail stock prices).  That stock paying out 2% in divs is either going to have share price that is dropping 2% more than the 0 div stock OR it is is outperforming.

Personally I expect a lot of traditional high dividend stocks to outperform the market during bear markets. It has what they have done in the past. The problem of course is they underperform in during the bull markets.  Having 150k cut to 75k during a bear market is bad. Having 100k cut to 75k leaves you in the same position.


People like to focus on the great depression but the 70s were worse (from a pure stock market point of view not a total economy point of view). Between Jan 1929 and 1939, you had  a real return  (after divs and inflation) of 5.33%.  And you were making a killing on your bonds. Between 1973 and 1983, you had a return of .16% and at the same time your bonds were losing money.  The good news is that we have products available today to help deal with that situation.


Let me put it more starkly. If you did a simulation of early retirees where you had two different scenarios, one with an average 7% annual price appreciation and the other with 3% price appreciation and 4% dividend yield. And both had the same volatility (say 15% annualized volatility). And both had the same withdrawal rate, the first one would have a higher failure rate. There would be some scenarios where the market tanks and stays down for 10 years and the retiree just sells off all his stock.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 06, 2014, 10:38:03 AM
Quote
Let me put it more starkly. If you did a simulation of early retirees where you had two different scenarios, one with an average 7% annual price appreciation and the other with 3% price appreciation and 4% dividend yield. And both had the same volatility (say 15% annualized volatility). And both had the same withdrawal rate, the first one would have a higher failure rate. There would be some scenarios where the market tanks and stays down for 10 years and the retiree just sells off all his stock.

If they have the same return, they will have the same failure rate if you take the same money out (there is a bit of hand waving as dividends tend to trail stock prices).  That stock paying out 2% in divs is either going to have share price that is dropping 2% more than the 0 div stock OR it is is outperforming.

I'm talking about a simulation where the second stock never has a dividend cut. For example, a $1.00 stock paying a $0.04 dividend. If the stock price falls to $0.50, then it still pays its $0.04 dividend (which is now 8%).

 A lot of people might think that's unrealistic, but the realistic case isn't as bad as a lot seem to think. To use your example, in 1973 the S&P was at 118.40 and paid a dividend of 3.16 (or 2.7%). In 1983, it was at 144.30 and paid a dividend of 6.88 (or 4.8%). Adjusting for inflation, the new dividend was 3.00. So, yeah, after adjusting for inflation the dividend got cut by about 5%. Not the end of the world, though. (I'm using data from Schiller's excellent excel spreadsheet (http://www.econ.yale.edu/~shiller/data/ie_data.xls) for 1/1973 to 1/1983, so our numbers might not agree exactly depending on which dates you used.)

But back to the simulation I proposed. Let me put it even more starkly, if the dividend does not get cut in dollar terms, then if you have a 4% withdrawal rate, failure is mathematically impossible in the second case, because the money our retiree is living off of is exactly equal to the dividend in dollars, and that dollar dividend is never cut. But in the first case clearly you still can have failure, since the results of our robotic 4%-withdrawing retiree depend on what stock prices are.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 06, 2014, 11:24:27 AM
As I said, obviously if you assume that dividends never go down then the conclusion will be that dividends are a secure income stream. That's a tautology, but a silly assumption. You might as well assume that stock (1) always grows at least 4% per year, it's the same assumption.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Ziggurat on April 06, 2014, 12:42:23 PM
I'd like to thank everyone for their posts here, very helpful for me in getting my head around all these issues.

I was leaning toward dividend growth style investing, but a couple of "aha" moments reading here have turned me back:

1. As mentioned, living off dividends requires a bigger stash to begin with.  That bigger stash would also give more safety to a fixed SWR route.

2. Dividend growth seems so safe because over the last X years, these big solid companies are still around and have not cut (or only cut a little) their dividends. Over the longer term, however, there is no guarantee those companies will still even exist, much less continue to thrive.  It requires the investor to spend a lot of time "picking stocks", and as we know, the vast majority of experts have not picked stocks successfully, certainly not enough to surpass the indexes.

This discussion also prompted me to read more, and I found a great series on canadian couch potato debunking dividend myths too, starting here (http://canadiancouchpotato.com/2011/01/18/debunking-dividend-myths-part-1/). I particularly like this part "Investors categorize $1,000 in dividends as income that they will happily spend, but the idea of selling $1,000 worth of stock is ďdipping into capital,Ē which causes them great anxiety" (true of me, I'll have to fight it).  Also, in part 6, they debunk the yield-on-cost idea, showing that you can sell your stock and immediately buy it back and get the exact same dividend income from it. 

Having said that, I will probably go for a bit of a hybrid approach, as I will likely need a somewhat stable income source to bridge for 10 years or so until taking pension.  Over short periods starting with a partial stash, if you will, some portion in dividend-solid companies would help smooth the bumps.  Over a small period, the risk of their demise is quite small.  Or, is even that kind of thinking not correct?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 06, 2014, 01:21:34 PM
As I said, obviously if you assume that dividends never go down then the conclusion will be that dividends are a secure income stream. That's a tautology, but a silly assumption. You might as well assume that stock (1) always grows at least 4% per year, it's the same assumption.

So I think we agree that my argument hinges on dividends being far more stable than stock prices. You think it's silly to assume that. I think it might be silly to assume they never go down at all, but it's not silly to assume they are far more stable than prices. In the '73-'83 period (which was picked by someone else because it was one of the worst in history for retirees), inflation-adjusted dividends dropped by only 5%.

What we really need as a test is to have data for two stock indices during that period. Say, the S&P non-dividend payers and the S&P dividend payers. Assume a retiree robotically withdraws 4% a year the first year and increases it by inflation. See where each one stands in 1983. I don't have the data, but I'm pretty sure I know what we'll see. If I have time I can do a similar test. I know XLU (utilities dividend paying ETF) data goes back to 1999. We could do the test on the S&P, which paid pathetic dividends back then vs XLU. I haven't done the test, but again I'm pretty sure I know the outcome.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 06, 2014, 01:42:50 PM
So you don't have actual evidence to back you up, but you're nonetheless sure what the outcome will be?

Businesses have three ways to use their profits: they can (A) pay a dividend, (B) buy back stock, or (C) reinvest to grow the business. (I'll ignore (C) for now since it's harder to analyse and so far we've been discussing the difference between (A) and (B) anyway.)

If you're a stockholder, then when the business pays out its profits to shareholders, you receive a share of those profits in proportion to the stock you hold. You can receive that same amount of money either (A) in cash, or (B) in your stock balance. The amount of money is decided by the profits of the business, and the proportion of stock that you hold - but not by the method it's paid out (taxes aside).

The actual profits a business makes, and the proportion of them that you receive, are not affected by the method that it pays them out. The only difference is that in (B), it's up to you how much you convert into cash.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: MDM on April 06, 2014, 03:24:07 PM
I don't have the data, but I'm pretty sure I know what we'll see. If I have time I can do a similar test. I know XLU (utilities dividend paying ETF) data goes back to 1999. We could do the test on the S&P, which paid pathetic dividends back then vs XLU. I haven't done the test, but again I'm pretty sure I know the outcome.
So you don't have actual evidence to back you up, but you're nonetheless sure what the outcome will be?

If forced, I might bet that warfreak2 is correct.  But I also have to give Eudo kudos for intellectual honesty: he has put forth a hypothesis, but also a test that could falsify it. (http://pages.cs.wisc.edu/~markhill/science64_strong_inference.pdf)  From that link: "
1) Devising alternative hypotheses;
2) Devising a crucial experiment (or several of them), with alternative possible outcomes, each of which
will, as nearly as possible, exclude one or more of the hypotheses;
3) Carrying out the experiment so as to get a clean result;
1') Recycling the procedure, making subhypotheses or sequential hypotheses
to refine the possibilities that remain;
and so on."
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 06, 2014, 03:40:45 PM
I'm actually not at all sure I would win that bet! It's possible that dividend-paying stocks (A) are more secure than stocks from businesses which use their profits to buy back shares (B). My point is that there's no mathematical reason for them to be different, and that the arguments presented so far don't establish a difference. However, an invalid argument does not an incorrect conclusion make - for example, perhaps reliably profitable businesses have some other reason to prefer paying out dividends than buying back stock?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: beltim on April 06, 2014, 04:37:55 PM
Category A beats category B for the same reason that most experts trail stock indices: company management is more likely to buy back stock when times are good are their share price is high than when the share price is low (when they would get the best deal).

https://doc.research-and-analytics.csfb.com/docView?sourceid=em&document_id=x454556&serialid=e45HdNbTyfzxqJiuVkQbC5cPZZDE1SdAOSK1XWRCbxs=

Edit:  Actually, I guess it's closer to the reason that most individual investors trail broad stock-market indices: poor timing.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Nords on April 06, 2014, 05:07:22 PM
Having said that, I will probably go for a bit of a hybrid approach, as I will likely need a somewhat stable income source to bridge for 10 years or so until taking pension.  Over short periods starting with a partial stash, if you will, some portion in dividend-solid companies would help smooth the bumps.  Over a small period, the risk of their demise is quite small.  Or, is even that kind of thinking not correct?
That hybrid approach is also known as "diversification".

If you want to get into picking dividend stocks (which is a lot of work when done correctly) then you could start with the Dividend Growth Investor's blog (http://www.dividendgrowthinvestor.com/) and with a library copy of Josh Peters' "The Ultimate Dividend Playbook". 

DGI is a blogging animal who puts out several posts per week, so it's probably better to subscribe via e-mail or RSS and then dig deeper when one of his posts catches your eye.  His key is focusing on the 300 or so stocks which have paid rising dividends for at least a decade, and diversifying among sectors.  If a holding cuts its dividend then he immediately sells, otherwise he's likely to hold for decades.

Personally I think it's easiest to buy an index fund or ETF like the Dow Dividend ETF (DVY).  It came through the 2008-09 recession with a 10%-15% dip in dividends (which has since returned), but if you kept DCA'ing into the fund then today you'd be looking at a double-digit yield on your original cost. 
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 06, 2014, 07:20:25 PM
I would bet on you losing the bet. Obviously to some extent it is going to come down to how you pick the div stocks but the traditional divs stocks (think Utils) tend to outperform in  bear markets. But the world doesn't start in 1973 or end in 1983. The better performance in the bear market might have followed a decade of underperformance on either side.  If it was a no brainer that you could have the same return and less variance by an investment strategy, everyone would do it.

I don't want to come across as anti divs. They are nice. But you don't want to chase them. I would rather retire with an S&P 500 portfolio with a 2% div than some subsector that you pick out that pays 4%.


I'm actually not at all sure I would win that bet! It's possible that dividend-paying stocks (A) are more secure than stocks from businesses which use their profits to buy back shares (B). My point is that there's no mathematical reason for them to be different, and that the arguments presented so far don't establish a difference. However, an invalid argument does not an incorrect conclusion make - for example, perhaps reliably profitable businesses have some other reason to prefer paying out dividends than buying back stock?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 06, 2014, 08:50:44 PM
Quote
If I have time I can do a similar test. I know XLU (utilities dividend paying ETF) data goes back to 1999. We could do the test on the S&P, which paid pathetic dividends back then vs XLU. I haven't done the test, but again I'm pretty sure I know the outcome.

-----
EDIT: Originally, I used the wrong data for XLU and got much more favorable results for it. I've corrected the data and changed some of the conclusions.
----

Ok, perhaps having a little OCD in me, I did the exercise. I looked at the price and dividends of XLU (a high dividend paying ETF) each year since 1999 (the first full year I have data for). Then I compared it with the S&P and its dividends during the same period. I created two fictitious retiree robots who started with $1 million each at the beginning and started withdrawing $40k a year, and increased their withdrawals with inflation each subsequent year. The data is below for all to critique and find my mistakes in, but here are the results:

The retiree who put all his money in the S&P ended up with $680k at the end of 2013. He's currently drawing down $56k a year, which is almost 10% of his portfolio, so he will be broke soon without moving to plan B. His dividends are paying him $13k.

The retiree who put all his money in XLU ended up with $902k at the end of 2013. He's also drawing down $56k a year and his dividends are paying 35k of that. Unfortunately for him, though, he's still taking a big chunk of his portfolio each year, so he probably won't have great results.

So in the 1999-2013 period, the dividend method works better than the non-dividend method. But it's important to not learn the wrong lessons from this. It's important to understand why it worked. The price of XLU was probably more stable than the price of the S&P, but that's not the main reason this worked. Look at the "XLU Div" column and compare with the "Withdrawal" column. His dividends were a large part of his withdrawals. When your dividends are higher than your withdrawals, the price of the stock you own doesn't matter. You're never selling stock, so what do you care what the price is? The important thing is that for this to work, your dividend must be somewhat stable and higher than your living expenses. The reason it this didn't work perfectly for retiree #2 was that even though XLU pays higher dividends, it still started with a low rate of 1.85%, so he was still selling stocks. If someone has their favorite dividend ETF that yields closer to 4% in 1999, I'm pretty sure you'll see much better results. It was the dot com bubble after all. And I keep claiming that dividends are very stable compared to stock prices, and apparently a lot of people don't believe it. This example encompassed both the dot com crash and the '08 stock crash and you can see that dividends were fairly stable.

Meanwhile, the S&P investor sold all his shares at the bottom. If you've ever looked at portfolio simulations, you know that this is the way portfolios fail: you sell your shares in a bear market, then the market eventually recovers, but you don't have any shares left, so it doesn't matter. You still go broke.

Keep in mind that there's a cost to this out-performance. This was a bear market. If we instead looked at '83-'93, I'm pretty sure you'd see the opposite. The non-dividend paying portfolio would outperform the dividend-payer. (Again, I haven't done the test, but I'm pretty sure I know how it would turn out :) ) That's the whole point. The original question was, "Why live off dividends?" and my answer was, "Because it gets rid of the sequence of returns risk, roughly." It gives in bear markets and takes away in bull markets. It's not for everyone, but the conventional wisdom is that if you need the income, a dividend portfolio will be more stable for you, and in this case I think the conventional wisdom is correct.

-------
Ok, here's the data. I got the data for XLU from Yahoo finance, and asked for monthly data for price and all dividends. (That's why the dates aren't exactly the first trade date of the year in all cases). The S&P and CPI data come from the Schiller Excel spreadsheet I mentioned in a different reply.


Date   CPI   XLU Price   XLU Div   XLU Div Rate   Beginning Balance   Capital Gain   Dividend   Withdrawal   Ending Balance
1/4/1999   164.30   30.23   0.56   1.85%   1,000,000    -85,676   18,525   40,000    892,848
1/3/2000   168.80   27.64   0.964   3.49%   892,848    118,874   31,140   41,096    1,001,767
1/2/2001   175.10   31.32   0.667   2.13%   1,001,767    -137,535   21,334   42,629    842,936
1/2/2002   177.10   27.02   0.92   3.40%   842,936    -259,557   28,701   43,116    568,964
1/2/2003   181.70   18.7   0.797   4.26%   568,964    155,476   24,249   44,236    704,454
1/2/2004   185.20   23.81   0.874   3.67%   704,454    136,985   25,859   45,088    822,209
1/3/2005   190.70   28.44   1.01   3.55%   822,209    107,257   29,199   46,427    912,238
1/3/2006   198.30   32.15   0.783   2.44%   912,238    125,983   22,217   48,278    1,012,161
1/3/2007   202.416   36.59   1.095   2.99%   1,012,161    72,752   30,290   49,280    1,065,923
1/2/2008   211.08   39.22   1.235   3.15%   1,065,923    -278,303   33,565   51,389    769,796
1/2/2009   211.143   28.98   1.273   4.39%   769,796    14,610   33,815   51,404    766,816
1/4/2010   216.687   29.53   1.004   3.40%   766,816    56,868   26,071   52,754    797,001
1/4/2011   220.223   31.72   1.368   4.31%   797,001    74,373   34,373   53,615    852,133
1/3/2012   226.665   34.68   1.123   3.24%   852,133    46,685   27,594   55,183    871,228
1/2/2013   230.28   36.58   1.465   4.00%   871,228    52,398   34,892   56,063    902,455



Date          CPI   S&P Price   S&P Div   S&P Div Rate   Beginning Balance   Capital Gain   Dividend   Withdrawal   Ending Balance
1/4/1999   164.30   1248.77   16.28   1.3%   1000000   141,595   13,039   40,000    1,114,635
1/3/2000   168.80   1425.59   16.57   1.2%   1,114,635    -70,338   12,958   41,096    1,016,160
1/2/2001   175.10   1335.63   16.17   1.2%   1,016,160    -148,677   12,302   42,629    837,156
1/2/2002   177.10   1140.21   15.74   1.4%   837,156    -179,419   11,554   43,116    626,174
1/2/2003   181.70   895.84   16.12   1.8%   626,174    165,435   11,268   44,236    758,640
1/2/2004   185.20   1132.52   17.60   1.6%   758,640    32,750   11,790   45,088    758,091
1/3/2005   190.70   1181.41   19.70   1.7%   758,091    62,449   12,643   46,427    786,756
1/3/2006   198.30   1278.73   22.41   1.8%   786,756    89,478   13,788   48,278    841,744
1/3/2007   202.416   1424.16   25.08   1.8%   841,744    -26,833   14,825   49,280    780,457
1/2/2008   211.08   1378.76   27.92   2.0%   780,457    -290,489   15,804   51,389    454,383
1/2/2009   211.143   865.58   28.01   3.2%   454,383    135,436   14,704   51,404    553,118
1/4/2010   216.687   1123.58   22.24   2.0%   553,118    78,293   10,950   52,754    589,607
1/4/2011   220.223   1282.62   22.96   1.8%   589,607    8,256   10,556   53,615    554,804
1/3/2012   226.665   1300.58   26.74   2.1%   554,804    76,708   11,405   55,183    587,734
1/2/2013   230.28   1480.4   31.54   2.1%   587,734    135,762   12,520   56,063    679,953

Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: MDM on April 06, 2014, 09:15:24 PM
...
I looked at the price and dividends of XLU (a high dividend paying ETF) each year since 1999 (the first full year I have data for).

Eudo, nice work and fairly presented with appropriate disclaimers. 

Went looking for more info on XLU (don't have that currently).  Found a few links with charts that look similar to this one:
(http://s28.postimg.org/6rcn9mom5/screenshot_3.png) (http://postimage.org/)

The starting 2013 value shows ~35, similar to your table, but the starting 1999 value appears closer to 30 instead of the 17.87 in your table.  Is there more than one XLU or am I missing something...?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 06, 2014, 10:01:03 PM

The starting 2013 value shows ~35, similar to your table, but the starting 1999 value appears closer to 30 instead of the 17.87 in your table.  Is there more than one XLU or am I missing something...?

No, it was my mistake. Yahoo finance provides data for the "adjusted stock close". I thought it was adjusted for splits only, but it was adjusted for splits and dividends. So I was effectively double counting dividends. I've corrected the original post with the correct data and changed some of the conclusion. The bottom line is that XLU still out-performed the S&P for the retiree over that time period, but not by nearly as much. (You end up with $902k, not $2.3 million. This is compared with the S&P which gives $680k). Big difference quantitatively, but same basic conclusion. The dividends even out the steep drops.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 06, 2014, 10:08:46 PM
XLU was at 30.02 . The 17.87 is an adjusted price that accounts for dividends and splits. I am guessing XLU never split and that dividends were basically double counted:). Since dec 1998 (inception), XLU has returned 5.83% with divs reinvested. Your money will not last 30 years with that type of return. Of course the s&p 500 returned 4.7% so your not living large off that either:)
 
You can look at DJU to see how bad this index underperformed from 1985 to 2000.  Looking at single 10-15 year periods isn't overly useful. You need to look at a ton of them and figure out what the best and worst cases are.


...
I looked at the price and dividends of XLU (a high dividend paying ETF) each year since 1999 (the first full year I have data for).

Eudo, nice work and fairly presented with appropriate disclaimers. 

Went looking for more info on XLU (don't have that currently).  Found a few links with charts that look similar to this one:
(http://s28.postimg.org/6rcn9mom5/screenshot_3.png) (http://postimage.org/)

The starting 2013 value shows ~35, similar to your table, but the starting 1999 value appears closer to 30 instead of the 17.87 in your table.  Is there more than one XLU or am I missing something...?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 06, 2014, 10:22:37 PM
XLU was at 30.02 . The 17.87 is an adjusted price that accounts for dividends and splits. I am guessing XLU never split and that dividends were basically double counted:). Since dec 1998 (inception), XLU has returned 5.83% with divs reinvested. Your money will not last 30 years with that type of return. Of course the s&p 500 returned 4.7% so your not living large off that either:)
 

Yes, that's exactly what happened. (It's been corrected in the original post.) And my conclusions exactly. (XLU out-performed, but neither retiree would be sleeping well at night these days.)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 07, 2014, 03:44:48 AM
The price of XLU was probably more stable than the price of the S&P, but that's not the main reason this worked. Look at the "XLU Div" column and compare with the "Withdrawal" column. His dividends were a large part of his withdrawals. When your dividends are higher than your withdrawals, the price of the stock you own doesn't matter.
This is a fundamental misunderstanding. The price of a stock reflects how reliably profitable the underlying business is, and the dividends are your share of the profits. The price of the stock obviously does matter, because a low price tends to mean that the business isn't doing so well, and that means it can't pay out its usual dividends, so to make up the difference you are going to have to sell some of your stock, and when you do so is going to be when the stock price is low.

Obviously the price of XLU was more stable because the dividends were reliable.

Quote
You're never selling stock, so what do you care what the price is?
As I said twice already, if you (ridiculously) assume "you're never selling stock", you are assuming that dividends are a reliable source of income, which is exactly what you are trying to prove in the first place.

-----

You managed to pick an ETF which (over this time period) paid reliable dividends, which means the businesses profited reliably. Moreover, over the 15 year period, if you include dividends, XLU grew (https://au.finance.yahoo.com/q/hp?s=XLU&a=00&b=1&c=1999&d=03&e=7&f=2014&g=m&z=66&y=132) by 130% (https://au.finance.yahoo.com/q/hp?a=00&b=1&c=1999&d=03&e=7&f=2014&g=m&s=xlu&ql=1), while VFINX (Vanguard's S&P 500 index fund) grew (https://au.finance.yahoo.com/q/hp?s=VFINX&a=00&b=1&c=1999&d=03&e=7&f=2014&g=m&z=66&y=132) by 90% (https://au.finance.yahoo.com/q/hp?s=VFINX&a=00&b=1&c=1999&d=03&e=7&f=2014&g=m&z=66&y=0). Annualised, XLU grew at 5.6% and VFINX at 4.3% - no shit, it was safer to withdraw from XLU. What you have shown is that if you pick an ETF that beats the S&P 500, then you can beat the S&P 500.

If you want to do this test in a fair way, you need to compare a dividend stock/ETF which, with dividends reinvested, would have performed pretty much equally to the S&P 500. If you want to compare the safety of your withdrawal, you need to compare between investments that do equally well with no withdrawal.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 07, 2014, 07:09:29 AM
The price of XLU was probably more stable than the price of the S&P, but that's not the main reason this worked. Look at the "XLU Div" column and compare with the "Withdrawal" column. His dividends were a large part of his withdrawals. When your dividends are higher than your withdrawals, the price of the stock you own doesn't matter.
This is a fundamental misunderstanding. The price of a stock reflects how reliably profitable the underlying business is, and the dividends are your share of the profits. The price of the stock obviously does matter, because a low price tends to mean that the business isn't doing so well, and that means it can't pay out its usual dividends, so to make up the difference you are going to have to sell some of your stock, and when you do so is going to be when the stock price is low.

Except for the fact that during a market crash, a solid business that is doing fine canand will have its stock price decrease simply due to the panic in the markets.  Big banks failing, for example, can cause unrelated stock price drops.  This doesn't mean that the unrelated business is not doing so well (aside from a "well the economy as a whole is worse, so it will affect this company as well ... maybe, somewhat, yes).

Yes, what I'm saying is during those (irrational) times, you may be smarter than the market.  Not able to time it, per say, but the market could be undervaluing a business that has no need to cut its dividends, or not by as much as the share price would indicate it should.

In other words, the share price reflects how profitable the business is, but it doesn't always accurately reflect that.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 07, 2014, 07:14:53 AM
You could go looking for another product maybe SDY ( the "aristocratic" div index) or REITs (they did ok in 2000-2002 which might be enough to  survive an a really brutal 2007-2008 stretch) to try an make the "income" strategy work but eventually you will find  that they have a 15 year period really doesn't look good when they are out of favor and if that period of time happens to start at the same time as your retirement, your screwed.

The big worry for me isn't surviving the bad years at the start sequence risk.  In those cases it is easy to go back to work. It is investing in underperforming assets that result in you having a declining standard of living and you being 65 and not in a great place to work.








XLU was at 30.02 . The 17.87 is an adjusted price that accounts for dividends and splits. I am guessing XLU never split and that dividends were basically double counted:). Since dec 1998 (inception), XLU has returned 5.83% with divs reinvested. Your money will not last 30 years with that type of return. Of course the s&p 500 returned 4.7% so your not living large off that either:)
 

Yes, that's exactly what happened. (It's been corrected in the original post.) And my conclusions exactly. (XLU out-performed, but neither retiree would be sleeping well at night these days.)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 07, 2014, 07:56:34 AM
Except for the fact that during a market crash, a solid business that is doing fine canand will have its stock price decrease simply due to the panic in the markets.  Big banks failing, for example, can cause unrelated stock price drops.  This doesn't mean that the unrelated business is not doing so well (aside from a "well the economy as a whole is worse, so it will affect this company as well ... maybe, somewhat, yes).

Yes, what I'm saying is during those (irrational) times, you may be smarter than the market.  Not able to time it, per say, but the market could be undervaluing a business that has no need to cut its dividends, or not by as much as the share price would indicate it should.

In other words, the share price reflects how profitable the business is, but it doesn't always accurately reflect that.
Yes, you're correct that I'm assuming efficient markets. I readily admit that there are various differences between dividend-paying stocks and non-dividend-paying stocks.

E.g., when a dividend is paid, the stock price goes down by what the market "expected the dividend to be". When the market underestimates dividends, the buy-and-hold investor receives more, and conversely if the market overestimates the dividends then the buy-and-hold investor receives less. What you propose is a psychological reason that the market might systematically underestimate the dividends.

I only argue against the alleged mathematical difference, which wasn't made with reference to market inefficiency.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 07, 2014, 08:19:05 AM
Agreed, there should be no difference in theory.

That just may be one reason why there could be a difference in practice.

I don't have enough data to determine either way, and I tend towards total market for other reasons (and cap gains in general over dividends for tax reasons).  But I can see why one would want to say it works that way.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: totoro on April 07, 2014, 08:51:14 AM
FWIW I don't use the 4% rule as my retirement calculator, although I do think it is a revelation.

I don't because:

1. I don't feel secure relying on the market for all time periods and needs.  I'm not a statistician/mathematician/engineer.  I do have experience with investments that did not perform well and I did need to cash out some of them at a loss.  I know that this was my lack of knowledge at the time, but I still am wary of relying on an index fund and I'm not naturally bent in a way that I can relax on the basis of probabilities and past performance.
2. I won't have the same financial needs each year due to paying for kids' education or receiving a pension.
3. I believe you need to save less if you use leverage plus tax planning to create an income stream through the use of rental properties and business dividends or eventual sale (yes, it is a bit more work).  Both rentals and businesses are responsive to my strategic planning/efforts/creative thinking - unlike an index fund.
4. I want my assets to continue to grow so that I can leave a charitable legacy or provide for the unexpected like a grandchild with a disability.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 07, 2014, 10:25:13 AM
1,2, and 4 are not really issues. They just requiring planning. 3 is the interesting one to think about. In real estate is gets hard to the same numbers that we get for the stock market so it is hard to evaluate risk. For example how did the landlord who owned 10 units due during the great depression? Or in a more recent case, what if you owned your units in 80s right as the bust started or if you loaded up on Detroit property in 1990? There used to be some really cool real estate empire blogs in the mid 2000 as people assembled empires. They pretty much have all gone silent when those 3 million in gains disappeared over the next 24 months and those cash flow positive properties turned bad.  Investing in the peaks of anything is always bad.

That being said, if I am in the right area in during my retirement, I expect to go back to owning rentals. Diversification of risk and all that. And no I don't think REITs perform the exact same role.

FWIW I don't use the 4% rule as my retirement calculator, although I do think it is a revelation.

I don't because:

1. I don't feel secure relying on the market for all time periods and needs.  I'm not a statistician/mathematician/engineer.  I do have experience with investments that did not perform well and I did need to cash out some of them at a loss.  I know that this was my lack of knowledge at the time, but I still am wary of relying on an index fund and I'm not naturally bent in a way that I can relax on the basis of probabilities and past performance.
2. I won't have the same financial needs each year due to paying for kids' education or receiving a pension.
3. I believe you need to save less if you use leverage plus tax planning to create an income stream through the use of rental properties and business dividends or eventual sale (yes, it is a bit more work).  Both rentals and businesses are responsive to my strategic planning/efforts/creative thinking - unlike an index fund.
4. I want my assets to continue to grow so that I can leave a charitable legacy or provide for the unexpected like a grandchild with a disability.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 07, 2014, 10:38:57 AM
There used to be some really cool real estate empire blogs in the mid 2000 as people assembled empires. They pretty much have all gone silent when those 3 million in gains disappeared over the next 24 months and those cash flow positive properties turned bad.  Investing in the peaks of anything is always bad.

I'd wager the vast majority of them were investing for appreciation, not cash flow, and were massively overleveraged.

If you've done it right, a recession and corresponding 20% drop in income and increase in vacancies will hurt, sure, but won't make you cash flow negative or cause you to lose any properties.

Do you have any links?  I'd love to read some, whether to laugh or learn, even if they haven't had new content for years.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: totoro on April 07, 2014, 01:35:58 PM
Investing for appreciation seems too risky to me and where I live in Canada I don't believe we will see appreciation for a while.  My view is that you want to look at cash flow and not care about appreciation/depreciation because you are never forced to sell. You choose the sale and time it to market conditions.

In our case, a nice four-bed/two-bath triplex unit in our neighbourhood is at least $500 000 per unit and often much more when you can find one.  If we wanted to stay in this neighbourhood we would have to pay a house off and invest about one million additionally to use the 4% rule and retire.  We want to stay in this neighhbourhood. 

We ended up buying a run-down multi-family with three units that is not strata (units can't be sold individually so valuation/unit is lower) for $750,000 with $150 000 down. We put an additional $50,000 in on repairs and renovations.   Total investment of $200 000. The rents from the other two units cover our mortgage and expenses.  It took us over a year of looking to find a place that would work this way.

In the end, instead of paying the principal and interest from our after-tax wages for a similar house, we have used only $200 000 and we own three units.  In addition, when the mortgage is paid off by rental income, we will have $800,000 in today's dollars in equity plus $3000/month in income from rent ongoing and a place to live mortgage-free or rent out if we want to travel.

In addition, this is our primary residence the capital gains on the percent of the structure we occupied will be tax exempt if we sell.  The rental income and expenses are deductible against interest creating a disincentive to pay off early as when it is paid off we will be in a lower tax bracket.

Rather than getting to one million invested and the amount required to pay off a house on after-tax wages, this strategy could allow someone to retire on substantially less invested capital over a shorter period of time.  It also lets them invest the portion they would have paid for a mortgage into other income-producing assets, like an index fund, along the way.

While I know this works for us, I also know that this is not for everyone.  We have relatives and friends that think it is quite odd that we live in a carriage house.  I think we get put into the "not very successful" box.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: foobar on April 07, 2014, 03:12:53 PM
I will have to go through biggerpockets and see if I can dredge them up. The general pattern they were in hot places like Vegas. They would buy and hold a bunch of units and would constantly be refinancing out (units were still cash flow positive in general but often times the margin was reduced). The the crash hit and vacancies doubled (or worse the tenant stopped paying but had to be evicted)  and rents dropped and then went from cash flow positive to negative. And of course that 2 million dollars in real estate was now worth 1 million but they owed the bank 1.5 million.  Mortgage payments stop getting made and the blogs go dead.


It is definitely easy to see the mistakes now (investing in bubble locations) and some even at the time (they were far to aggressive with leverage). But how much of that is like saying don't invest in tech stocks in 1999 and you should be 100% in stocks?:)


There used to be some really cool real estate empire blogs in the mid 2000 as people assembled empires. They pretty much have all gone silent when those 3 million in gains disappeared over the next 24 months and those cash flow positive properties turned bad.  Investing in the peaks of anything is always bad.

I'd wager the vast majority of them were investing for appreciation, not cash flow, and were massively overleveraged.

If you've done it right, a recession and corresponding 20% drop in income and increase in vacancies will hurt, sure, but won't make you cash flow negative or cause you to lose any properties.

Do you have any links?  I'd love to read some, whether to laugh or learn, even if they haven't had new content for years.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 07, 2014, 03:59:32 PM
I will have to go through biggerpockets and see if I can dredge them up. The general pattern they were in hot places like Vegas. They would buy and hold a bunch of units and would constantly be refinancing out (units were still cash flow positive in general but often times the margin was reduced). The the crash hit and vacancies doubled (or worse the tenant stopped paying but had to be evicted)  and rents dropped and then went from cash flow positive to negative. And of course that 2 million dollars in real estate was now worth 1 million but they owed the bank 1.5 million.  Mortgage payments stop getting made and the blogs go dead.


It is definitely easy to see the mistakes now (investing in bubble locations) and some even at the time (they were far to aggressive with leverage). But how much of that is like saying don't invest in tech stocks in 1999 and you should be 100% in stocks?:)

I lived through the Vegas bubble burst.  Vacancies went up a bit, but doubling .. maybe from like 4% to 8%?  And rents stagnated, but didn't drop (all the foreclosed homeowners suddenly needed a place to rent)

Like I said:
I'd wager the vast majority of them were investing for appreciation, not cash flow, and were massively overleveraged.

If you've done it right, a recession and corresponding 20% drop in income and increase in vacancies will hurt, sure, but won't make you cash flow negative or cause you to lose any properties.

I'm sure they were cash flow negative (in fact I know it, because our prices from 05-07 couldn't have been cash flow positive based on our rents, unless you put down something like a 70% down payment) and speculating on appreciation.  Whoops.  :)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 07, 2014, 06:15:06 PM
This is a fundamental misunderstanding. The price of a stock reflects how reliably profitable the underlying business is, and the dividends are your share of the profits. The price of the stock obviously does matter, because a low price tends to mean that the business isn't doing so well, and that means it can't pay out its usual dividends, so to make up the difference you are going to have to sell some of your stock, and when you do so is going to be when the stock price is low.

Ok, so I just want to make sure weíre on the same page here, so I know where the disagreement is. Do you agree that

(a)   If the dividend of a stock is not cut, and you are living on less than the size of the dividend, then it is mathematically impossible for your portfolio to fail, no matter what price the stock trades at?

(b)   If you are living on the same amount as (a) but own non-dividend paying stocks it is possible for your portfolio to fail if the stock price falls low enough for long enough?

It sounds to me like you also believe these statements, but are arguing that it doesnít matter because whenever stock prices fall, dividends are cut. I think this is just false, and it has nothing to do with inefficient markets or irrational traders. Stock prices can fall quite rationally, even without an expectation of a dividend cut. (They can fall irrationally, too, of course.) Think of US treasury bonds. They pay a coupon analogous to stock dividends. The market places roughly a 0% chance of the US government defaulting on its interest payments. Yet the price of bonds (aka interest rates) swing up and down all the time (http://static6.businessinsider.com/image/4fc7964feab8ea060d000003/long-term-interest-rates-us.png).

In fact speaking of bonds, this is a perfect analogy. There are regular coupon-bearing bonds which pay some amount (say, 4% a year), and there are also zero coupon bonds (http://en.wikipedia.org/wiki/Zero-coupon_bond) that pay no coupon. They are sold at a discount to their face value, and then at maturity you redeem them for face value. So you get your return entirely through price appreciation. This is very analogous to dividend-paying and non-dividend-paying stocks. If your argument is correct, it seems to me you would argue that thereís no real reason for coupon bearing bonds to exist. Why donít we all just buy zero coupon bonds? Isnít it a lot easier to just have one big payment at the end? And then if you retire and need cash flows, why donít you just sell off little chunks of your zero coupon holdings? The reason is that the prices of zero coupon bonds are very volatile. You donít know what bond prices (aka interest rates) will be when you need to sell, so you could end up getting very bad results, depending on the path of bond prices over the next several years. This is a well-known phenomenon and is the flip side of reinvestment risk (http://www.investopedia.com/terms/r/reinvestmentrisk.asp). (If you don't need the cash flows any time soon, itís better to buy a zero coupon bond because otherwise youíre going to get coupons that you will have to reinvest at some unknown future interest rate). In the bond world, this is all very well-understood. If you need regular cash flows a regular coupon bond gives more predictable, less volatile results. The only difference is that Iím applying the same reasoning to stocks and dividends. The math is the same, though.

The argument that thereís no mathematical difference between a company paying dividends and a company buying back shares sounds very similar to the argument Buffett gave in his 2012 shareholders letter (http://www.berkshirehathaway.com/letters/2012ltr.pdf) for why he doesnít pay dividends (pg. 19). But his argument works. He gives a mathematical example showing that his shareholders will be better off if he doesnít pay dividends, and they just sell off parts of their holdings if they need money. But he makes it clear that one of his assumptions is that the price of BRK never goes too low! In his case, it makes sense because he then goes on to say that he has a policy of always buying back shares if they ever drop below 1.2 times book value. Heís putting a floor on the stock price.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Another Reader on April 07, 2014, 06:19:58 PM
My experience in Phoenix during the crash was that rents stagnated, then went up.  Vacancy and collection loss went up as jobs were lost but went down later when people lost their houses in foreclosure or short sales and had to rent.  Values went down by as much as 2/3, but as long as you weren't overleveraged or had negative cash flow, you were just fine.  The same was true of my dividend paying stocks, except for the banks.  Overall, the loss of income was small, and the income was independent of how markets viewed the value of the underlying real estate or businesses on any given day.

If I was relying on selling 4 percent of my portfolio to pay my expenses during that time, I would have been hurt.  If I was getting an average of two percent in dividends and selling to make up for the deficit, the blow would have been softened.  Mostly I deposited the checks, worried unnecessarily about structural changes in the markets that largely did not occur, and went about my business.  I also added to my income producing real estate portfolio at very favorable prices at the market bottom.

And that's why it really is all about the income.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: warfreak2 on April 08, 2014, 11:29:04 AM
(a)   If the dividend of a stock is not cut, and you are living on less than the size of the dividend, then it is mathematically impossible for your portfolio to fail, no matter what price the stock trades at?

(b)   If you are living on the same amount as (a) but own non-dividend paying stocks it is possible for your portfolio to fail if the stock price falls low enough for long enough?
This is a bogus comparison, because you're assuming total stability for the first stock, but you have no similar assumption for the second stock. The analogous assumption for (b) would be: the company has totally stable profits, it regularly spends the same chunk of its profits buying back shares, and your withdrawal is always less than your proportion of those profits (an analogous assumption), then it would likewise be mathematically impossible for your portfolio to fail.

There just isn't any magic in dividends. None. If you reinvest all your dividends, you have stock in the same company, with the same profits; it's equivalent to a non-dividend-paying stock, yet it's just as stable and reliable as a dividend-paying stock. Weird! Dividends exist because it's simpler and easier for the company to pay its shareholders in cash rather than by increasing the share price; not because they magically allow the company to pay the investors more (or more reliably) using the same damn profits.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: beltim on April 08, 2014, 01:28:35 PM
(a)   If the dividend of a stock is not cut, and you are living on less than the size of the dividend, then it is mathematically impossible for your portfolio to fail, no matter what price the stock trades at?

(b)   If you are living on the same amount as (a) but own non-dividend paying stocks it is possible for your portfolio to fail if the stock price falls low enough for long enough?
This is a bogus comparison, because you're assuming total stability for the first stock, but you have no similar assumption for the second stock. The analogous assumption for (b) would be: the company has totally stable profits, it regularly spends the same chunk of its profits buying back shares, and your withdrawal is always less than your proportion of those profits (an analogous assumption), then it would likewise be mathematically impossible for your portfolio to fail.

This is an interesting comparison, and I think  you've identified a legitimate difference, but I still think you're incorrect.  If you assume constant profits for both a and b, and live only on the dividends for a, you clearly can't have your portfolio fail.  Now, the question is whether company b, which bought back stock with an equivalent percentage of profits as company a, could ever fail.  And the answer to that theoretical question is obviously yes.  Take a company like Tata motors.  From 2008 to 2009, their sales doubled, their profits also went up, but the stock went down by about 2/3.  Why?  Because of fears about the global economy.  Because someone selling stock is exposed to the marketplace, they are dependent on the share price - specifically, what others are willing to pay for their shares.  That variability introduces the way for that portfolio to fail that is not present in the company a example.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: beltim on April 08, 2014, 01:31:25 PM
Also, I'd encourage you to read, the link I posted above about how company management times stock buy back decisions very poorly.  This negatively affects stock value compared to dividends.  It wouldn't if companies had constant buy back policies like most dividend-paying companies do with dividends, but very few companies have such a steady buyback policy. And the ones that do tend to have the best results - that's also shown in that report.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 09, 2014, 06:13:57 PM
Also, I'd encourage you to read, the link I posted above about how company management times stock buy back decisions very poorly.  This negatively affects stock value compared to dividends.  It wouldn't if companies had constant buy back policies like most dividend-paying companies do with dividends, but very few companies have such a steady buyback policy. And the ones that do tend to have the best results - that's also shown in that report.

By the way, I don't know about anyone else, but the link was broken for me (required a Credit Suisse login)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: beltim on April 09, 2014, 06:16:18 PM
Also, I'd encourage you to read, the link I posted above about how company management times stock buy back decisions very poorly.  This negatively affects stock value compared to dividends.  It wouldn't if companies had constant buy back policies like most dividend-paying companies do with dividends, but very few companies have such a steady buyback policy. And the ones that do tend to have the best results - that's also shown in that report.

By the way, I don't know about anyone else, but the link was broken for me (required a Credit Suisse login)

That would explain why no one addressed it.  Weird, because I have no connection or login for Credit Suisse.  Let's try: http://www.google.com/url?sa=t&rct=j&q=credit%20suisse%20adding%20value%20or%20destroying%20value%3F&source=web&cd=1&ved=0CCgQFjAA&url=https%3A%2F%2Fdoc.research-and-analytics.csfb.com%2FdocView%3Fsourceid%3Dem%26document_id%3Dx454556%26serialid%3De45HdNbTyfzxqJiuVkQbC5cPZZDE1SdAOSK1XWRCbxs%3D&ei=iuJFU4S3KISdyQHvvoHwAQ&usg=AFQjCNFCUHmca-Qnzwc9RH5K1jP42Cb_eQ&bvm=bv.64507335,d.aWc
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on April 09, 2014, 06:23:14 PM
That link works, beltim.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Eudo on April 10, 2014, 06:54:29 PM
That would explain why no one addressed it.  Weird, because I have no connection or login for Credit Suisse.  Let's try: http://www.google.com/url?sa=t&rct=j&q=credit%20suisse%20adding%20value%20or%20destroying%20value%3F&source=web&cd=1&ved=0CCgQFjAA&url=https%3A%2F%2Fdoc.research-and-analytics.csfb.com%2FdocView%3Fsourceid%3Dem%26document_id%3Dx454556%26serialid%3De45HdNbTyfzxqJiuVkQbC5cPZZDE1SdAOSK1XWRCbxs%3D&ei=iuJFU4S3KISdyQHvvoHwAQ&usg=AFQjCNFCUHmca-Qnzwc9RH5K1jP42Cb_eQ&bvm=bv.64507335,d.aWc

That actually is a great article. They did exactly what I've wanted to do for a while. I've looked at individual companies and anecdotally found that it seemed that companies that buy back a lot of shares more often than not are just trying to undo the dilution from large option exercises by executives, and since executives exercise their options when stocks are high, these companies systematically buy shares whenever the price is high. It's good to have a more systematic study that confirms it. And that chart is killer. Huge share repurchases in 2007 that dry up as soon as the market tanks. Meanwhile, dividend payments are like a machine that just keeps chugging along.

The one point I wish they had made was that management often has a financial incentive not to pay out dividends. At some point folks got it in their heads that if you give executives a lot of stock options, then their interests are aligned with shareholders. But options only benefit from a rise in share price, not from dividend payments. So if you have money burning a hole in your pocket, the last thing you want to do is pay dividends with it. Far better to buy back shares, even at outrageous prices.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 03, 2014, 12:54:38 PM
Sorry for digging up an old thread but this is the best one I've found that addresses some questions that have been bouncing around in my head.  It seems to have been left unresolved though, so hoping some of you are up for more arguing on the subject :-)  Particularly warfreak2 and the like, as right now I'm leaning towards Eudo's side and am looking for counter points.

What I keep coming back to is how a dividend based portfolio for income (not reinvesting dividends for appreciation) effects success rate compared to an s&p index and using a % SWR.  I'm having a hard time finding comparisons other than the one Eudo did earlier in the thread using a single dividend-oriented fund with a single time period.  The calculators don't seem to allow you to run comparisons on all 30 year periods using different indexes, unless I'm missing something.

I do occasionally hear anecdotal accounts of things like 'during the 08/09 crash my dividends dropped 10% while stock prices dropped 50%' which is encouraging, but if it's sacrificing growth during the good times then it may cancel out, which is why I'm mostly interested in portfolio success/failure rates over all 30-year spans.

As I'm starting to look into dividend investing, other than being a hobby I may enjoy (haven't gotten far enough to decide yet), it's a lot more work than just doing a 4% SWR.  If it means for a safer portfolio I'll continue down the path, but if not then being rather lazy and would prefer to avoid the extra effort if there's no/little point to it ;-)

So I guess my main question is, is anyone aware of resources for how dividends effect portfolio success rates?  Or would I need to build a spreadsheet for that myself (which may or may not be beyond my ability)?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: MDM on December 03, 2014, 01:07:33 PM
So I guess my main question is, is anyone aware of resources for how dividends effect portfolio success rates?  Or would I need to build a spreadsheet for that myself (which may or may not be beyond my ability)?
I believe the Trinity et al. studies used generic "stock" and "bond" returns.  The stock returns would have been part price appreciation and part dividend reinvestment.

A lot of the back-and-forth in this thread is based on what one believes about dividends: if you believe that a company never cuts its dividend then it will be "safer" than a company that never pays dividends (all other things being equal, which of course they never are).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 03, 2014, 01:17:19 PM
A lot of the back-and-forth in this thread is based on what one believes about dividends: if you believe that a company never cuts its dividend then it will be "safer" than a company that never pays dividends (all other things being equal, which of course they never are).

Right, but even when companies do cut dividends, they as a whole tend to be more stable than stock prices (from what I've seen, or is that wrong?), which for income (not talking about building the stash), stability can be important, but I'm curious how important (safe) that really is.

I know picking companies that don't cut dividends, and rather finding ones that always grow them, is what dividend growth investing is all about, but tracking over multiple 30-year periods the success rate of hand-pick stocks that will change as better options become available would be just about impossible.  Using dividend-focused indexes would be a reasonable trade-off and at least give a trend of how investing for, and living off, dividends effects success rate.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: skyrefuge on December 03, 2014, 02:08:48 PM
So I guess my main question is, is anyone aware of resources for how dividends effect portfolio success rates?  Or would I need to build a spreadsheet for that myself (which may or may not be beyond my ability)?

First, it's incorrect to set up a battle between "dividends" and "4% SWR". They are not opposing strategies. That's because "4% SWR" also involves dividends. 4% is the Safe Withdrawal Rate from a historical portfolio of both dividend and non-dividend paying stocks. Even if your dividend income exceeds your expenses, you still need to decide "can I spend all that dividend income, or do I need to reinvest some of it to keep from running out of money?" And the SWR research says: no, it has not always been safe to spend all your dividends.

Otherwise, why not just put your whole portfolio in one of the 350 stocks currently yielding more than 4% (http://www.dividend.com/dividend-stocks/high-dividend-yield-stocks.php) (or an index of all of them) and call it a day as you luxuriate in the >30% yield thrown off by some of them?

Given today's low dividend yields, we're tempted to believe that "4% SWR" tells us we can spend all our dividends, and then generate the rest of our cashflow by selling shares. But in reality, it's also a ceiling on how much of our dividend income we can spend, in cases where dividend yield is greater than 4%.

Between 1906 and 1954, S&P 500 dividend yield averaged 5.67% (http://www.multpl.com/s-p-500-dividend-yield/table). Yet for the 19 30-year cycles in that period, even if we don't spend all of the dividends (starting with a 5% WR), 47% of them fail.


I posted another example in this other thread (http://forum.mrmoneymustache.com/investor-alley/investment-strategy-focus-on-dividend-or-capital-appreciation/msg466997/#msg466997), which I'll repost here:
======================
Dividend payouts may be more volatile than you realize. In the US, say you owned enough shares of VTINX (S&P 500 index fund) in 2007 to produce your necessary income of $1000 per month. Here's how that income would have changed over the next 6 years:

2007: $1000
2008: $1008
2009: $847
2010: $791
2011: $903
2012: $1088
2013: $1189

"$791" sure doesn't equal "about $1000", at least not in my mind.

In order to have generated that $1000/month income from dividends in 2007, you would have needed a stash of ~$630,000.

In contrast, if you had started with only $300,000 and simply withdrawn/sold 4% each year, that would have been sufficient to generate a much-more-steady $1000/month income for the entire time. And while your net worth would have certainly been volatile over that period, your balance at the end of 2013 would have been $341,846, or 14% greater than when you started.
======================

I'm not aware of any other resources out there to compare portfolio success rates on dividend-focused portfolios. It was hard enough to come up with the limited stuff I came up with in this post. It almost makes you think, if no one has compiled the data to show the superiority of dividend-focused portfolios, maybe that's because no such data exists? :-)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on December 03, 2014, 02:27:17 PM
There's no such thing as a free lunch.

Understand where dividends are coming from (hint: profits the company makes from selling goods/services) and ask yourself what is the fundamental difference in the profits collected by companies paying them and not (hint: none - a company that profits $Y and distributes some as a dividend is the same as a company that profits $Y and doesn't have a dividend, in terms of the amount of money they made).

If a company is valued based on its assets, earnings, etc. then a company that retains the money should go up higher than the money that distributes the dividends (by the amount of the dividend).

Thus you could sell that company and end up in the same place.

There's no reason to think a company with dividends will make more money, and if they don't make more money, why would they be worth more?

The dividends is the company giving you some of the profit, and then it's worth less that amount, and the valuation follows accordingly.  The non-divided company is still worth that amount, and it's valued accordingly.

Example:
Company A distributes a 3% dividend and goes up 7%.  CAGR: 10%
Company B doesn't have a dividend, and goes up 10%.  CAGR: 10%

Tell me, why do you think company A would go up more than company B, just because it distributes dividends?

It won't.

So by focusing on dividend companies, you're not gaining any benefits, but you may have some drawbacks (like not controlling the distribution of your income, worse tax situation, etc.).
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 03, 2014, 02:48:23 PM
Tell me, why do you think company A would go up more than company B, just because it distributes dividends?

I don't, that's why I specified I'm not talking about growing the stash, but spending it.  I couldn't care less about dividends while I'm still working.  My concern is around a more stable stream of income once I FIRE.  I know there's no free lunch, dividend investing is way more work ;-)  I'm just trying to figure out if it's worth it.

======================
Dividend payouts may be more volatile than you realize. In the US, say you owned enough shares of VTINX (S&P 500 index fund) in 2007 to produce your necessary income of $1000 per month. Here's how that income would have changed over the next 6 years:

2007: $1000
2008: $1008
2009: $847
2010: $791
2011: $903
2012: $1088
2013: $1189

"$791" sure doesn't equal "about $1000", at least not in my mind.

In order to have generated that $1000/month income from dividends in 2007, you would have needed a stash of ~$630,000.

In contrast, if you had started with only $300,000 and simply withdrawn/sold 4% each year, that would have been sufficient to generate a much-more-steady $1000/month income for the entire time. And while your net worth would have certainly been volatile over that period, your balance at the end of 2013 would have been $341,846, or 14% greater than when you started.

Not quite the comparison I was looking for, but it did bring up another point I hadn't thought about.  Living off dividend income means living on a variable income stream.  If the market tanks again and dividends drop say 10%, you have to adjust your spending to account for that instead of steadfastly increasing it by 3% again that year.  I imagine this would be a big part of why it MAY be more successful than the blind 4%-inflation-adjusted-every-year models.  However, dropping your spending even a little bit in down years can be accounted for in cfiresim and it very significantly increases the success rate.

Thanks for the input, the picture is becoming clearer.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on December 03, 2014, 03:52:05 PM
Tell me, why do you think company A would go up more than company B, just because it distributes dividends?

I don't, that's why I specified I'm not talking about growing the stash, but spending it.  I couldn't care less about dividends while I'm still working.  My concern is around a more stable stream of income once I FIRE.  I know there's no free lunch, dividend investing is way more work ;-)  I'm just trying to figure out if it's worth it.

Okay, awesome.  So you realize the companies should grow the same, and that means when spending it, it's six of one, half dozen of the other.

Whether you have to sell shares or you get a dividend, the company's total return is the same, so you won't end up ahead at all while spending it if you receive dividends.

Using our same company A/B scenario from above:
Company A grows 7%, distributes 3% dividend.  You live on 3% of your stache, so the dividend covers your spending, and your stache grows 7%.

Company B grows 10%, have no dividend, so you sell 3% to live on, and your stache grows 7%.

You end up the same.  If you recognize that there's no reason for a company distributing dividends to grow more than one that doesn't, then you selling shares is the exact same as getting a dividend.

So your concern about "spending" the stache works out the same as someone growing it: either way you're cutting into the company's growth, it's just are you cutting into it by selling shares, or are they cutting into it by giving you the dividend.  It nets out the same.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 03, 2014, 04:12:14 PM
So your concern about "spending" the stache works out the same as someone growing it: either way you're cutting into the company's growth, it's just are you cutting into it by selling shares, or are they cutting into it by giving you the dividend.  It nets out the same.

But that's not so clear in down markets.  It works out the same when things are going up, but what happens when a companies stock drops say 10% this year, but the dividend stays the same or still goes up?  In the first case you lose 10% plus spend 4%, so next year it has to rebound 14% just to get back to where you were (plus another 4% so you can withdrawal again).  The whole backwards dollar cost averaging thing.  In the latter case, the share price recovering doesn't matter.  I guess you could make the argument that paying out the dividend reduced the ability for the company to recover.  But for that we'd have to assume that stocks always drop for a rational reason and then we end up in an efficient market debate :-)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on December 03, 2014, 04:29:28 PM
I guess you could make the argument that paying out the dividend reduced the ability for the company to recover.  But for that we'd have to assume that stocks always drop for a rational reason and then we end up in an efficient market debate :-)

You don't have to assume that they drop for a rational reason, but just that the drops in company A and B are approximately the same (i.e. a dividend stock doesn't drop less than a non-dividend one, just because it gives out dividends).  I think this is a fairly reasonable assumption, in broad strokes.

Either way the best thing to do in down markets is be flexible.

Owning dividend stocks that may well underperform long term (due to a flight to dividend stocks causing company A to be OVER valued compared to company B) doesn't make sense, to me.  It's a type of trying to outguess the market, which is a fool's game.  Thinking your dividend stocks will perform better just because they output dividends is irrational.  And if you accept that they won't perform better, why are you investing in them, given the potential downsides?
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: Breaker on December 03, 2014, 07:36:06 PM
WOW!! This discussion has gotten pretty deep and I'm going to have to spend some time reviewing it.

As for searching for previous threads on the Forum I don't find it very helpful.  The answers it comes up with often don't include threads that I have read and know are there somewhere.

On the matter at hand.  I like the idea of paying attention to income stream.  I am getting income from a very small Gov't pension, a rental, and dividends if needed.  I will also receive SS.  Two of these streams are/will be pretty stable, Pension and SS.  The rent and dividends may fluctuate a lot.  I have no one that I have to take care of after I die so that may be different from most on the Forum.  For me it is all about income in retirement. 
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 04, 2014, 11:02:43 AM
Either way the best thing to do in down markets is be flexible.

Owning dividend stocks that may well underperform long term (due to a flight to dividend stocks causing company A to be OVER valued compared to company B) doesn't make sense, to me.  It's a type of trying to outguess the market, which is a fool's game.  Thinking your dividend stocks will perform better just because they output dividends is irrational.  And if you accept that they won't perform better, why are you investing in them, given the potential downsides?

I don't think they'll under or over perform with respect to stock price.  What I keep circling back to is reverse dollar cost averaging of a standard 4% (or whatever) withdrawal portfolio when the market is declining.  If dividend payouts are more stable than stock prices (has this been shown?  I feel like it has but I don't have any references), then does that help your portfolio ride out storms?  If so does it come at a detriment during good times?

Sorry for beating a dead horse, just trying to fully understand and hash it out.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on December 04, 2014, 11:09:10 AM
Either way the best thing to do in down markets is be flexible.

Owning dividend stocks that may well underperform long term (due to a flight to dividend stocks causing company A to be OVER valued compared to company B) doesn't make sense, to me.  It's a type of trying to outguess the market, which is a fool's game.  Thinking your dividend stocks will perform better just because they output dividends is irrational.  And if you accept that they won't perform better, why are you investing in them, given the potential downsides?

I don't think they'll under or over perform with respect to stock price.  What I keep circling back to is reverse dollar cost averaging of a standard 4% (or whatever) withdrawal portfolio when the market is declining.  If dividend payouts are more stable than stock prices (has this been shown?  I feel like it has but I don't have any references), then does that help your portfolio ride out storms?  If so does it come at a detriment during good times?

Sorry for beating a dead horse, just trying to fully understand and hash it out.

Again, there's no such thing as a free lunch.  :)
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: RyanAtTanagra on December 04, 2014, 11:18:35 AM
Again, there's no such thing as a free lunch.  :)

Eh, I could respond to that by saying of course not, dividend growth investing is more work than just buying an index fund and withdrawing 4%, which is why you get better results (with regard to portfolio success rates over multiple 30-year terms).  Not saying I believe that, I'm just trying to decide if it's the case or not.
Title: Re: Forget the 4% SWR, or Any SWR - It's All About Income
Post by: arebelspy on December 04, 2014, 12:47:54 PM
Again, there's no such thing as a free lunch.  :)

Eh, I could respond to that by saying of course not, dividend growth investing is more work than just buying an index fund and withdrawing 4%, which is why you get better results (with regard to portfolio success rates over multiple 30-year terms).  Not saying I believe that, I'm just trying to decide if it's the case or not.

It doesn't have to do with the work involved, but the total return.