Post retirement: Buy Index vs Buy dividend paying stocks ?

[Ferrisbueller]

Retirement is some way off for me but I'm interested in this question and most google searches throw up partisan arguments written by index or dividend "believers" though one or two do have hard metrics.

My reasons for preferring the index approach post retirement are:

- greater diversification through much larger number of stocks
- costs likely lower
- lower risk of 'getting the call wrong'
- returns aligned to economy as a whole
- easy to enter/exit
- simpler to understand (no co. research needed)

So overall the index approach is significantly lower risk in my view.

Post retirement do you plan to buy and index and sell as required for income or purchase a number of dividend paying stocks and not sell but replace if dividend ceases or is reduced?

If you plan on buying dividend stocks how many will you buy, what criteria for selection (duration of paying dividends i guess is big here) and most of all how do you reconcile the inherent uncertainty that a co. can stop paying dividends anytime?

Anyone using dividend paying funds ?

[Thegoblinchief]

I've seen people do well with either approach.

The simplest answer is personality. Do you want your investing to be mostly hands-off? Index, rebalance to desired AA once a year. Only consider DGI if you're willing to educate yourself about how to evaluate stocks, read corporate statements, and all the things which go into proper due diligence.

There are a variety of excellent DGI blogs. Educate yourself. See if the nerd-level appeals to you. It doesn't appeal to me, though I can appreciate the insight someone like Joshua Kennon can gather when doing case studies and evaluations of a company.

Around here, I'd PM spoonman for sure.

[Retired To Win]

... If you plan on buying dividend stocks how many will you buy, what criteria for selection (duration of paying dividends i guess is big here) and most of all how do you reconcile the inherent uncertainty that a co. can stop paying dividends anytime?...

I've chosen the dividend stocks route.  I maintain a portfolio of 16 to 24 stocks.  Theoretically, the portfolio is supposed to be composed of 16 equal-weighted stocks so that no stock represents more than 6% of the portfolio (and I limit the exposure to any industry to 12%).  But, in reality, some of the companies I "handicap" to account for some degree of financial wimpiness somewhere.  That means that some of my positions I've limited to 3% of the total portfolio.  So, I generally run with about 20 individual stocks.

That helps me to deal with your second question.  The damage to the portfolio of any one company stopping dividends is limited because no stock is allowed to carry that much weight in the portfolio.  And increases in dividends by other companies, and the more-than-occasional realized capital gain, do compensate for the ones that go (hopefully temporarily) belly up.

But you (meaning I) do have to stay on top of the companies' news feeds to catch updrafts or downdrafts early enough to be able to do something about them.  And knowing when the dividend announcement should be happening -- and being ready to pull that trigger if the announcement is late -- requires organized vigilance.

So, this is not investing you can put on "autopilot."  I find the analysis involved to be enjoyably challenging, so I'm OK with it.  But not everyone would be.

[Monkey Uncle]

The dividend approach you are describing sounds like you would live solely off the dividends without ever selling (unless something goes wrong with the company).  This would require a much larger 'stache than the typical safe withdrawal rate approach.  At a 4% SWR, you would need a $1,000,000 'stache to generate $40k/year.  If you're living solely off of the dividend yield (probably about 2.5%), you'd need $1,600,000.  The upside is that you have zero risk of running out of money.

[chuckaluck]

Post retirement do you plan to buy and index and sell as required for income or purchase a number of dividend paying stocks and not sell but replace if dividend ceases or is reduced?

If you plan on buying dividend stocks how many will you buy, what criteria for selection (duration of paying dividends i guess is big here) and most of all how do you reconcile the inherent uncertainty that a co. can stop paying dividends anytime?

Anyone using dividend paying funds ?

Why not have the best of both worlds?  For a good proportion of my portfolio, I invest in Vanguards Equity Income fund as my passive dividend paying stock fund.  It seems to have most of your criteria: excellent fund company, no-nonsense approach, wide diversification, low cost, etc and pays 2.61% dividend (if typical annual capital gains are include, then closer to 5%).   My wife and I use the passive income from this fund to pay for our vacations.  I haven't touched ---- nor worried about ---- the principal for years.   

[ImCheap]

I have some cash in a Dividend Index Stock Fund ETF (VIG). In the grand scheme of things I don't much difference in the overall return between a total market fund.

The Dividend ETF spews out a little higher dividend that at my tax rate is 0% but my long term capital gains are basically 0% so I could just as well sell some of a total market fund if all was equal.

A little pile in a Dividend Stock ETF may make for a little less trading. If/when they change the tax system in someway that may skew things on way or another as well.

In this current environment I don't see much advantage either way. If I was holding some individual stocks I may look at it differently.

[nereo]

The dividend approach you are describing sounds like you would live solely off the dividends without ever selling (unless something goes wrong with the company).  This would require a much larger 'stache than the typical safe withdrawal rate approach.  At a 4% SWR, you would need a $1,000,000 'stache to generate $40k/year.  If you're living solely off of the dividend yield (probably about 2.5%), you'd need $1,600,000. The upside is that you have zero risk of running out of money.

Danger! Danger! Danger!  In the interest of people not getting the completely wrong idea, going with a dividend strategy will not lower your risk of running out of money.  In fact, in most cases it will increase your risk with the same WR compared with a SP500 index fund or total market fund.  That's because you may hold 6-20 stocks in a dividend portfolio, and the failure of one or two during a crisis can seriously screw your portfolio.

Yes, in the case above the poster would be extremely unlikely to run out of money, but only because he/she would be using a 2.5% WR.  But they would have even less risk if they put all of that in an index fund.

[Retired To Win]

The dividend approach you are describing sounds like you would live solely off the dividends without ever selling (unless something goes wrong with the company).  This would require a much larger 'stache than the typical safe withdrawal rate approach.  At a 4% SWR, you would need a $1,000,000 'stache to generate $40k/year.  If you're living solely off of the dividend yield (probably about 2.5%), you'd need $1,600,000.  The upside is that you have zero risk of running out of money.

Well, I don't actually make any buys thinking about selling.  But I fairly frequently do sell if and when a stock in my portfolio has spiked up in price by at least 10%.  (Hence my observation regarding "more than occasional realized gains.")  And then very often I end up buying that same stock back after its price has slipped back down.

Those realized gains, I've come to see, every year actually exceed what the portfolio throws off in dividends (which, by the way, is way more than 2.5%).  So, at least so far, I haven't had a need to supercharge the portfolio's size in order to have it generate pretty decent passive income.

One last comment.  No matter what one does or how one is invested, there is always going to be SOME risk of running out of money.  The trick is to be able to manage that risk.

[sol]

I think dividend stocks are in a classic pump and dump bubble.  Too much enthusiasm from people selling get rich quick schemes, too much widespread popularity of the sector compared to fundamentals. They've outperformed of late solely because of all of the hype.

Vanguard's research team agrees with me. They called to confer before publishing their December 2014 economic and investment outlook white paper.

[deborah]

Vanguard's research team agrees with me. They called to confer before publishing their December 2014 economic and investment outlook white paper.

Which one of them is your personal fiend?

[Eric]

You'll probably want to read this thread before switching to or deciding on a dividend focused approach:

http://forum.mrmoneymustache.com/investor-alley/ive-decided-on-vanguard-but-need-some-help-please/

[sol]

Vanguard's research team agrees with me. They called to confer before publishing their December 2014 economic and investment outlook white paper.

Which one of them is your personal fiend?

Oh we're all homies.  The Christmas party at my place last year was cray-cray.  Bogle had his tie around his forehead.

[deborah]

Ha ha! Thanks Sol

[nereo]

Vanguard's research team agrees with me. They called to confer before publishing their December 2014 economic and investment outlook white paper.

Which one of them is your personal fiend?

Oh we're all homies.  The Christmas party at my place last year was cray-cray.  Bogle had his tie around his forehead.

oh man, that was your house we trashed?  Sorry about all the wine stains on the ceiling.  Hey, I'm still missing my favorite pair of boxers from that party - they say "i heart SP500" all over them... any chance they turned up?

[RexualChocolate]

The dividend approach you are describing sounds like you would live solely off the dividends without ever selling (unless something goes wrong with the company).  This would require a much larger 'stache than the typical safe withdrawal rate approach.  At a 4% SWR, you would need a $1,000,000 'stache to generate $40k/year.  If you're living solely off of the dividend yield (probably about 2.5%), you'd need $1,600,000. The upside is that you have zero risk of running out of money.

Danger! Danger! Danger!  In the interest of people not getting the completely wrong idea, going with a dividend strategy will not lower your risk of running out of money.  In fact, in most cases it will increase your risk with the same WR compared with a SP500 index fund or total market fund.  That's because you may hold 6-20 stocks in a dividend portfolio, and the failure of one or two during a crisis can seriously screw your portfolio.

Yes, in the case above the poster would be extremely unlikely to run out of money, but only because he/she would be using a 2.5% WR.  But they would have even less risk if they put all of that in an index fund.

+1.

If you want to live off of dividends, use an income paying vanguard fund. Investing in a limited number of stocks (that you're picking due to dividend criteria) gives an inferior risk weighted return relative to the index funds. You'll always have firm specific risk you won't have in an index.

Great that it works for people. It's still stock picking and adds more risk than the index strategy.

[PencilThinStash]

I've had some success with Vanguard's REIT Index. The investor shares currently trade around half the cost of VTSAX - With less money invested in my REIT, it still throws off more dividend income every quarter than my Total Market Index shares do. Not as effective as picking individual dividend stocks, I'm sure, but it's been an easy way to up my dividends a little while keeping all the laziness of an index investor.

*If somebody is smarter than me and thinks this is a stupid idea, call me out on it. Always willing to learn more.

[RexualChocolate]

I've had some success with Vanguard's REIT Index. The investor shares currently trade around half the cost of VTSAX - With less money invested in my REIT, it still throws off more dividend income every quarter than my Total Market Index shares do. Not as effective as picking individual dividend stocks, I'm sure, but it's been an easy way to up my dividends a little while keeping all the laziness of an index investor.

*If somebody is smarter than me and thinks this is a stupid idea, call me out on it. Always willing to learn more.

It's way better than picking individual stocks. Nothing wrong with tilting with a small piece of your portfolio- which is what this is. Remember REITs have had banner years the last few but are very susceptible to market crashes.

It's very tax inefficient though, so definitely hold in a non taxable account if youre in accumulation phase. If you're retired, not a bad way to gain some additional exposure.

[skyrefuge]

*If somebody is smarter than me and thinks this is a stupid idea, call me out on it. Always willing to learn more.

Ok, good...time to put on your learnin' hat.

If by "investor shares currently trade around half the cost of VTSAX" you're referring to the share price (or Net Asset Value), you need to stop caring about that. Share price is an entirely irrelevant piece of information when comparing investments. Its only use is to compare the current market value of a single investment to its value sometime in the past (and even then it's not very useful).

If you instead just mean that "you pay less to get $1 of divdends from VGSLX than to get $1 of dividends from VTSAX", then sure, that's true, but the common way of expressing this is via their dividend yields. VGSLX currently "yields" 3.19%, while VTSAX yields 1.79%.

But most importantly, dividends aren't a sensible way to measure your "success", particularly for a 24-year-old who has absolutely no need for dividends. When a fund pays you dividends, they are hurting their share price. Dividends don't actually make you money (and they explicitly cost you money if held in a taxable account).

For visual evidence, see the two charts below. The first shows the 10 year price chart for the REIT fund (blue line) vs. the Total Stock Market fund (orange line). Stocks beat the REIT by almost 30%. But that's because the price chart ignores dividends. In the total return chart, which includes dividend reinvestment, the situation is flipped, with the REIT slightly beating Total Stock. If the REIT had held onto its dividends rather than paying them out (which is not actually legal for a REIT), then its price would be higher today and the price comparison would look similar to the total return comparison.

REIT vs. Stock Market, Price Chart
REIT vs. Stock Market, Total Return Chart

It's ok to put some money in REIT investments, but the dividend income is *not* a rational reason for doing so.

[PencilThinStash]

*If somebody is smarter than me and thinks this is a stupid idea, call me out on it. Always willing to learn more.

Ok, good...time to put on your learnin' hat.

If by "investor shares currently trade around half the cost of VTSAX" you're referring to the share price (or Net Asset Value), you need to stop caring about that. Share price is an entirely irrelevant piece of information when comparing investments. Its only use is to compare the current market value of a single investment to its value sometime in the past (and even then it's not very useful).

If you instead just mean that "you pay less to get $1 of divdends from VGSLX than to get $1 of dividends from VTSAX", then sure, that's true, but the common way of expressing this is via their dividend yields. VGSLX currently "yields" 3.19%, while VTSAX yields 1.79%.

But most importantly, dividends aren't a sensible way to measure your "success", particularly for a 24-year-old who has absolutely no need for dividends. When a fund pays you dividends, they are hurting their share price. Dividends don't actually make you money (and they explicitly cost you money if held in a taxable account).

For visual evidence, see the two charts below. The first shows the 10 year price chart for the REIT fund (blue line) vs. the Total Stock Market fund (orange line). Stocks beat the REIT by almost 30%. But that's because the price chart ignores dividends. In the total return chart, which includes dividend reinvestment, the situation is flipped, with the REIT slightly beating Total Stock. If the REIT had held onto its dividends rather than paying them out (which is not actually legal for a REIT), then its price would be higher today and the price comparison would look similar to the total return comparison.

REIT vs. Stock Market, Price Chart
REIT vs. Stock Market, Total Return Chart

It's ok to put some money in REIT investments, but the dividend income is *not* a rational reason for doing so.

Thanks for the input, skyrefuge! The higher yield is what I'd been trying to comment on, my apologies for not stating that better.

Dividend income hadn't been my end goal with the REIT, I just wanted to have a small share of my portfolio focused on real estate until I can afford a down payment on a rental property. The fact that it threw off half-decent dividends was purely a side benefit.

Considering how well the REIT Index has been doing lately, I've actually been considering cashing out and adding those dollars to my down payment. Sell high, right?

[TheFrugalFox]

I am 40, retired and live in South Africa. I am using the dividend method - but sure it's not for everyone. Have around 30 companies, 1/3 in REITS. Pays over 4% in dividends and increase should on the whole beat inflation.

Basically, works for me for tax reasons. Plus would feel like I am getting poorer selling the capital. Have managed to put in a few shares that will give the portfolio a bit of growth - has been going well and comfortably beat the AllShare index last year.

I also let the dividends accumulate for a year, then withdraw the lot to live on for that year - so no surprises plus a bit of warning if things are looking tight.

But early days - happy to change if it does not work out. That said, so far my portfolio is ahead of my expectations which was doubling the capital every 5 years - this is SA with higher inflation though.