b00gs wrote: ↑Thu Sep 14, 2023 2:18 pm
I know points 1, 2, and 4. I was looking into it a bit more and it looks like most of the dividend payouts are not even profits or premiums they are collecting. It's majority investor capital, so you're just getting your money back in increments. Is that what you're saying in point 3? I have to look into it more...
I was thinking that I can keep my money in growth ETFs and then move over to dividends/YLDs when I'm ready to retire.
3 is sort of a hidden inevitability. You've have to already have experience investing to really wrap your head around it... which is convenient, because they are built so perfectly to capture the attention of novice investors.
Here's one attempt to try to illustrate the issue.
Consider SPY, a fund where by and large the gains come from a gain in price, not the dividends.
You start investing in 2018. You've got 100k, put it all at once, and never touch it again.
Year 1: 100k [-4.56%] -> 95,440
Year 2: 95,440 [31.22%] -> 125,236
Year 3: 125,236 [18.37%] -> 148,242
Year 4: 148,242 [28.74%] -> 190,847
Year 5: 190,847 [-18.17%] -> 156,170
(I'm sure there's some rounding errors, but it's illustrative.)
If you just straight up ignore the fluctuations year to year, and just look at the start to finish results, you can get an annualized rate.
Depending on whether you use geometric or arithmetric means, this works out to be roughly 10% per year. Try it for yourself by taking 100k * 1.1 five times in a row.
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This rate of growth just discussed is CAGR, or total return. That is, how much did I put in and how much is it worth now.
Now the game becomes SIGNIFICANTLY MORE COMPLICATED when you start slushing funds in and out. But it all falls into three mathematical cases:
1) Withdrawals are less than the total return
2) withdrawals are roughly equal to total return
3) withdrawals are lager than total return.
Case 1: Withdrawals less than total return (~3% annual withdrawals vs a 10%ish growth rate)
Same trade. Spy 2018 through 2022. But we take out 250/month. Maybe we want to start buying supplies for a community garden, or just go out and do a random act of kindness every week, and this is just the cost of a good habit
Year 1: 100k [-4.56%, and withdrawals] -> 92,615
Year 2: 92,615 [31.22%, and withdrawals] -> 118,074
Year 3: 118,074 [18.37% and withdrawals] -> 136,029
Year 4: 136,029 [28.74% and withdrawals] -> 171,417
Year 5: 171,417 [-18.17% and withdrawals] -> 136,869
Annualized Total Return: 7.3%.
You successfully took some money every month; and since it was less than growth rate you also got to enjoy a little bit of growth as well.
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Case 2: Withdrawals roughly equivalent to total return (~8.5% annual withdrawals vs a 10%ish growth rate)
You decide to pull out about 700/month, maybe to help pay some bills for a kid going to grad school.
Year 1: 100k [-4.56%, and withdrawals] -> 87,526
Year 2: [31.22%, and withdrawals] -> 105,170
Year 3: [18.37% and withdrawals] -> 114,024
Year 4: [28.74% and withdrawals] -> 136,406
Year 5: [-18.17% and withdrawals] -> 102,103
Annualized Total Return: 0.4%.
You successfully pulled out a significant chunk of money each month; however, because the number you choose very closely matched the underlying strategy, you received virtually no growth.
Or perhaps, viewed in a different way, you could think of it as you having spent your future growth along the way, in monthly chunks.
Case 3: Withdrawals exceeding the total return rate. (18% annual withdrawals, vs a 10%ish growth rate)
You decide to start pulling out 1500/month. Maybe you're finally going to buy that camper van and travel the US, or you're going to finally get that piece of property you've always been dreaming of. There's some really significant things, and life experiences you can have at this level (most people have a family member whose entire life would change and would have your undying loyalty if you simply gift them amounts approaching this for example).
Year 1: 100k [-4.56%, and withdrawals] -> 78,477
Year 2: [31.22%, and withdrawals] -> 82,231
Year 3: [18.37% and withdrawals] -> 74,905
Year 4: [28.74% and withdrawals] -> 74,163
Year 5: [-18.17% and withdrawals] -> 40,297
Annualized Total Return: -12%
You spent an incredible 90k (1500/month for 60 months straight!), and you still have a sizable chunk left over. Clearly this isn't going to last forever.
But it's important to keep in mind how much spending you got to enjoy over this time period. Also note that this rate is fairly close to what a 1% monthly payout would be (1k/month vs 1500/month)
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What ends up happening to most investors is that they don't realize that the 1%/month payout rate of YLDs are almost always Case 2 AT BEST, and Case 3 in most other scenarios. That does not make them a BAD investment by any means. It just means that you have to realize that if you fully spend the monthly dividend, you should expect a graceful spend down. For many people, this is actually fantastic. But novice investors will never sit down and run the math on these to understand this fundamental reality of how the funds operate.
In my opinion, they are best suited for getting novice investors involved in the market as quickly as possible. They just make the owners feel so good (You mean I'm going to get a check for over 100/month? EVERY MONTH??!?! This is GREAT!), and it just makes them want to invest more and more to see how high they can push up that monthly payment. Mathematically, it's not as good as just putting into an index and chill. But that requires a level of commitment a lot of people aren't ready to sign up for. Imagine if you started in year 5, and watched 20% of your total net worth disappear in a single year. Are you SURE you won't have your faith tested a little? YLD owners don't care; they just shrug their shoulders while their 1k/month payment just keeps rolling in. It's easy to be disciplined when you're getting checks direct deposited. It just has a psychological effect on holders that cannot be underestimated.