Dividends over 4% rule

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arrrrgon
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Dividends over 4% rule

Post by arrrrgon »

I haven't been on in a while mostly because the extreme side of things just didn't pan out for me, but you guys are still the smartest group I've talked with so I thought maybe someone could help me out with something.

I've been thinking a lot about investments and the 4% rule, and I just can't wrap my head around why this alternative wouldn't work. I've seen people talk about companies not paying dividends during down times or changing dividends etc.., but it's not like I couldn't move things around during those times. Anyways:

Let's say you needed $50,000 a year to get by, and you could get an average of 10% in dividends on $500,000 spread across a decent amount of stocks (around 7-10 in my testing). Now let's assume that your portfolio is $800,000 so you've got an extra $300,000 cushion to live off of during the hard times.

Let's say the other $300,000 is split 55/10/35 between large cap stocks, crypto, and money market account(or gold when it's not looking overvalued). In this way you would have exposure to growth in large cap stocks and bonds. You would have the potential to sell crypto during booms to fund the rest of your portfolio while not risking too much in a crash. Finally the $100,000 in money market or gold would be available during down times for the market.

Am I just being overly optimistic, or is this a viable option?

Just a note. These numbers are just examples. I just wanted some numbers that made sense to me given the budget above.

Crusader
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Re: Dividends over 4% rule

Post by Crusader »

I don't think you can get a portfolio of companies that pay 10% dividends, at least not with the risk that the usual stock market has, nor do I think a 10% dividend yield is sustainable. Besides, I don't think you should focus on dividends:
https://www.investopedia.com/terms/d/di ... evance.asp

Salathor
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Re: Dividends over 4% rule

Post by Salathor »

I think the MOST you can hope for in dividends should probably skew closer to the ~3% that VYM and VYMI pay. If you're chasing 10% in dividends you're giving up an exceptional amount of safety for yield, and it will come back to bite you later.

TANSTAAFL, especially in highly liquid equity markets.

steelerfan
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Re: Dividends over 4% rule

Post by steelerfan »

Just my opinion, but 10% on 500K is too high of a rate to bank on without taking on a lot of risk. There are a couple of people on here that juice things up by doing options that are blowing it up but I am a coward and not as smart as most here. Assuming your 800K example, If you need 50K I would invest 700K which would be a more attainable but still not with risk 7% rate. It kind of sounds like that is what you are doing. I am pretty much the same. You mentioned crypto. I have crypto as well but value it at zero and do not count it in my budget numbers. I bought most of it over 4 years ago and it is in off-site cold storage. If I die my family will probably not be able to unlock it LOL. It is for truly an apocalypse. I don't think about it much.

The 100K remaining would cover 2 years and you could always extend that by getting something if SHTF long before you exhaust your emergency fund.

steelerfan
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Re: Dividends over 4% rule

Post by steelerfan »

Obviously the 4% rule is about depleting a balanced 50/50 stock/bonds portfolio and probably is no longer applicable anyway. It is not about what you want to earn in a stock dividend or even a total return on a dividend growth stock which damn well better be more than 4%... It also assumes you are looking at a 30 year retirement and will be dead in 30 years. The antithesis of what this site is about.

In practice you will very likely do close to that 10% a year. Hell, I earned close to 30% last year!. Obviously crazy The big risk is sequence risk which is mitigated with your emergency fund and the willingness to be an old person working in an amazon fullfillment sweatshop ala Nomadland someday!

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C40
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Re: Dividends over 4% rule

Post by C40 »

Yes, that is definitely a viable option.

10% is too high of an expectation for dividend yield though. Very few companies ever sustain that high of a yield.

Personally, I would expect 3-4% in post-tax accounts where you want qualified ordinary dividends, and up to 5%-6% in a 401k/IRA where you could/would buy some REITS, MLP

Qazwer
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Re: Dividends over 4% rule

Post by Qazwer »

https://www.nerdwallet.com/article/inve ... end-stocks

Total return makes more sense than dividend. Currently, companies are not focused on dividend pay outs (tax reasons). Link above top 25 US stock for dividends

If you had a time machine, standard Oil would have been a good call for dividends. My admittedly poor interpretation of investment history of the past 150 years is 3 eras: Bonds,then Dividends and then Total Return
This is based on ownership laws and tax laws.
Might want to consult a historian though for a better analysis

jacob
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Re: Dividends over 4% rule

Post by jacob »

arrrrgon wrote:
Mon May 24, 2021 4:48 pm
Am I just being overly optimistic, or is this a viable option?
It's overly optimistic/not at all a guarantee. High yielders (above the real growth rate of the economy) are high because they have a low price and they have a low price because they have a low or negative growth rate or because they are risky(*) (value traps).

(*) I use the practioner's definition of "probability of permanent loss" rather than the academic's definition of moving volatility.

If there's a downturn in the economy or their respective sector, you'll see the dividend get cut.

Another red flag is a high debt/equity ratio. (Certain real estate, utilities, telephones, tobacco, ...) This works when it works because stable businesses with cash flow can be levered up but if it fails the business is in trouble and the dividend will be cut to service the debt.

IOW, remember to subtract inflation (because the dividend is unlikely to grow or it will grow at a snail's pace) and realize that during a recession these guys will be the first to receive cuts which will sink the share price proportionally.

JCD
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Re: Dividends over 4% rule

Post by JCD »

Let's attack this a few ways:
- What can produce 10% returns?
- Are these good investments?
- Can you exit dividend cutting periods?  
- Are dividends good or bad and in what measure?

I think jacob's answer is great for the theory, but I'm going to try to capture a concrete example.

What can produce 10% returns?

Let me pick out two examples, mreits (Mortgage REITs) and AT&T.  ATT was producing a ~7% yield, mreits can produce 8-12% dividends at least in the last couple of years.  To give a concrete example, NLY has a 9.5% return and has had a 8-12% return for years.  I don't think a 10% dividend return on capital is completely out of range, particularly if you're willing to lever up just a tiny bit.  MLPs also have historically tended to be over 10%, but I've got very little to say on those.  My vague understanding is that many MLPs are not renewable per-se.  That is to say, once the oil field is empty or the mine mined, your MLP has no value left and I don't believe your invested capital is returned to you (please feel free to correct me, I don't do anything in MLPs).     Overall, I would say it is possible to create a portfolio that is 10% returns.   

Are these good investments?  

So in ATT's case, it was a high risk and has been known to be for years.  It was I believe the world's most indebted public company. The price of the company has been sitting between 40 and 25 for many years, but in general it is trending downward.  It was using debt to pay the dividend and it seemed to be run in questionable ways.  Given the recent outcome with the dividend cut and the price of shares dropping quickly you'd have to say no, it was not a great investment.  Some mreits had similar problems in the 2008 crash.  Arbor Realty Trust for example went from mid 30s to about $.50 or about 98% drop.  Arbor is now about half way back to its high. So yes, they can be fine investments, but I wouldn't want my entire net worth tied up in these things. Even trying for ~4% yields leads to questionable results.

Much of the rest of the downsides of these high paying dividend yielders has been covered by jacob and others. Without growth in the company, the dividend can't grow, so you would have to save part of the 10% to generate simulated "growth". Also without growth you have to ask if the company has pricing power if inflation becomes a thing.

Can you exit dividend cutting periods?

Arbor lost half its value in 6 months in the 2008 crisis, and it dropped a similar percentage in 2011, where nothing happened and it quickly recovered.  I did not investigate their dividend history, but at least on pure price movement it is clear there is a lot of noise in that signal.  The fact is with ATT you had 4 business days to get out once the discovery deal was announced, which implicitly meant the dividend was getting cut or you faced a 10% drop in the price, a year's worth of dividends.  I've not tried to quantify this in any serious model, but if you even vaguely buy into the EMH. you're going to have some serious doubt on being able to exit before the smart money is gone.

Are dividends good or bad and in what measure?

From a tax perspective dividends are generally thought of as bad.  In ERE land, you may pay very little taxes on dividends and thus there might be some arbitrage there.  Beyond that, dividends in the past proved a company had cash--they were trustworthy.  As the anti-fed'rs would put it, the low interest rates have left serious doubt about who is wearing what and when the tide will go out.  Or in plain English, the low interest rates and easy money mean that companies can be like ATT and pay their dividend for years while failing to make money.  There is no doubt in my mind that some signal exists for dividends not paid by debt, but that is dependent on you being willing to do the accounting.  Still, it gives hope that the company's numbers are real, since that dividend had to come from somewhere.  I recall reading in a book that there has been historically a dividend premium where buying high paying dividend companies were better compounders in the long run. It isn't clear this is still true.

The question of dividends payers being better companies will lead you to the "great debate" of "growth vs value."  Dividends mean the company has nothing better to do with the cash, which implies value.  On the other hand, in recent decades everyone wants the 40% YoY growth names hoping to win by owning Amazon.  Some see these stocks as lotto ticket companies where you only need one to make you rich while others see them as Ponzi schemes.  Either way, fund flows have not been going to dividend stocks nor is there much faith in them compared to growth stalwarts like Microsoft or Google, much less Tesla or Nio.  The debate will rage on why value has generally underperformed, but whatever the reason is, playing dividends is playing on the losing side of the fence, at least in the recent past.

IlliniDave
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Re: Dividends over 4% rule

Post by IlliniDave »

I tend to agree with what Jacob said. Dividends are paid out in $/share so the dividend rate is sort of the market's opinion of how desirable (i.e., reliable) buying into that income stream is. If it was desirable, the stock price would rise making the dividend yield fall until it was aligned with the broader market yields. Last I checked the SP 500 dividend yield was under 1.4%, and decent dividend funds are generally under 3%. So 10% payers are priced at a third of the market. Might be a good contrarian play for someone more interested in capital appreciation than dividends, but it's risky.

I have no comment on crypto, but otherwise given the assumptions, the math works. The question is whether maintaining a portfolio that meets the assumptions over a long haul is viable.

arrrrgon
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Re: Dividends over 4% rule

Post by arrrrgon »

Thanks for the replies guys. The crypto portion was really just meant to represent the current speculative plays of the time. Right now that means crypto. I think it will mean crypto through at least 2025. Who knows after that. When I first tested this it was before the market had fully recovered, so things like XOM were in play for 10% dividends. Of course it was made up of things ranging from 6-14% as some of it was REITs, and some of it was large caps that were just being hit by the Covid timeline. Even now XOM is offering 6% which is amazing for that particular stock.

In theory you could buy up and coming stocks that are still undervalued and currently have a high yield. You could hold those stocks for their 12% dividend while they're rising and then diversify that money into other stocks when the yield drops down below 5%. I've tested this on some, but obviously not enough to know if it can work long term.

Honestly the part of investing I understand the least is bonds. I'm not even sure they would really be included in my final portfolio. I think I'd be more likely to stick almost entirely to the stock market.

Based on what many of you are saying it sounds like I should focus on the 7% range if I ever actually reach my goals. I'm not close yet, so this is all just theory and planning for the future.

Of course I'd still have the option of working part time or consulting too, but conversations like this help to wrap my head around it all.

steelerfan
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Re: Dividends over 4% rule

Post by steelerfan »

I own a lot of the crappy value trap stuff that Jacob was talking about. (T/VZ/MO/BTI/Utilities/NLY). While it is true these companies don’t really grow they are a cash machine - until they aren’t. I balance this out by taking risk with positions in growth stocks (NIO in a $4, PLTR in at $15) At this point NIO is my 2nd largest position. I think as JSD alluded to the smart money has left T and I will likely be a bagholder again but mildly interested in the spinoff shares which will probably pan out as well as their other media efforts LOL. I like action and swinging for the fence probably more than the average person here.
I keep it fairly small so when I invest in UNIT ACB or GEO and it goes to shit I still can sleep at nights. Still have money coming in from Lending Club that is in runoff earning about 6.25%.

I think there is room for small speculative plays provided you have a solid income stream coming in.

arrrrgon
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Re: Dividends over 4% rule

Post by arrrrgon »

steelerfan wrote:
Tue May 25, 2021 9:37 am
I own a lot of the crappy value trap stuff that Jacob was talking about. (T/VZ/MO/BTI/Utilities/NLY). While it is true these companies don’t really grow they are a cash machine - until they aren’t. I balance this out by taking risk with positions in growth stocks (NIO in a $4, PLTR in at $15) At this point NIO is my 2nd largest position. I think as JSD alluded to the smart money has left T and I will likely be a bagholder again but mildly interested in the spinoff shares which will probably pan out as well as their other media efforts LOL. I like action and swinging for the fence probably more than the average person here.
I keep it fairly small so when I invest in UNIT ACB or GEO and it goes to shit I still can sleep at nights. Still have money coming in from Lending Club that is in runoff earning about 6.25%.

I think there is room for small speculative plays provided you have a solid income stream coming in.
I like this idea, and have thought about it some. There are almost always high risk/high reward opportunities out there, so you could be pulling 15-20% off of a small portion of your portfolio while letting the rest grow safely. This might allow for an earlier timeline with the caveat that if this fails in the first year or two you'd need to go back to work.

Right now one could earn massive amounts of income just from defi interest on stable coins, but those interest rates can only last so long.

I may need to spend some time learning to trade options, so that my entire plan doesn't require high dividends or unattainable interest rates.

Lucky C
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Re: Dividends over 4% rule

Post by Lucky C »

a) If you're a bull you could use 300% leverage to get 4% dividend yield from the S&P500.

b) If you're a bear you could invest 0% in equities and wait until the S&P500 falls to a third of its current price in order to buy with a 4% yield.

c) If you don't know whether the market is going to go up or down, you could work longer so that you can afford to buy the same amount of dividends (or share of sales or earnings...) you would need in a typical "20th century 4% SWR successful backtest" scenario, at today's much higher prices.

Clearly (c) is the most reasonable approach which has the best chance of success. When markets are at extremes your default position should be that you will have to work longer than you may have projected when planning to dollar cost average into stocks with an average valuation (over the working years). Being able to still work the same number or fewer years than anticipated would require exceptional circumstances, like succeeding in the risky endeavor of (a) without blowing up, or correctly timing an extreme situation like (b), or simply being a superior individual investor over multiple market cycles (a rare feat!).

WFJ
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Re: Dividends over 4% rule

Post by WFJ »

4% dividend portfolio might be appropriate for someone with a very short time horizon, say 10 years. Longer than this will result in owning dead money stocks and busting any ERE plan. A major weakness of the 4% or any SWR calculation is the probability of failure geometrically increases over time. The probability of failure of three 65 year old people each enjoying a 15 yr retirement is much smaller than one 35 yr old enjoying a 45 yr retirement. A high dividend will, for the first group, result in very few failures, while a dividend strategy for the latter individual is almost guaranteeing failure. Most financial calculators are constructed for a 60-70 yr old retiring for 10-20 years and longer time horizons create all kinds of statistical issues with estimations.

elegant
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Re: Dividends over 4% rule

Post by elegant »

WFJ wrote:
Tue Jul 13, 2021 4:00 pm
4% dividend portfolio might be appropriate for someone with a very short time horizon, say 10 years. Longer than this will result in owning dead money stocks and busting any ERE plan. A major weakness of the 4% or any SWR calculation is the probability of failure geometrically increases over time. The probability of failure of three 65 year old people each enjoying a 15 yr retirement is much smaller than one 35 yr old enjoying a 45 yr retirement. A high dividend will, for the first group, result in very few failures, while a dividend strategy for the latter individual is almost guaranteeing failure. Most financial calculators are constructed for a 60-70 yr old retiring for 10-20 years and longer time horizons create all kinds of statistical issues with estimations.
Lots of unsupported blank statements here.

WFJ
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Re: Dividends over 4% rule

Post by WFJ »

elegant wrote:
Wed Jul 21, 2021 7:22 pm
Lots of unsupported blank statements here.
Which statements? What is your stats background? The best way to understand these statements is to build spreadsheets with real data, run 1000 simulations and create your own failure estimates based on your own collected data, returns, distributions and volatility estimations. The probability of busting increases geometrically with an increase in duration of retirement (ERE) and also when substituting the general market for dividend paying stocks. One needs to build these templates to understand these relationships as the canned programs provided by the financial services industry are dangerously biased to the upside (which should not be a surprise). There are hundreds of videos on how to build these templates in a spreadsheet.

WFJ
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Re: Dividends over 4% rule

Post by WFJ »

elegant wrote:
Wed Jul 21, 2021 7:22 pm
Lots of unsupported blank statements here.
New research.

https://investornews.vanguard/fueling-t ... -retirees/

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