A Dividend Blend for Today

I examined a realistic dividend blend. It produces a continuing withdrawal rate of 6% of the original balance (plus inflation).

Conditions Examined

Investments

BAC 8.5% preferred (callable in 5 years).
DVY 4.25% yield with a growing dividend amount of 6% per year.
TIPS at 2%.
Inflation at 3%.

Automatic Allocator results:

With a 50%-50%-0% TIPS combination: 6.095% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 6.125% continual withdrawal rate.

Excursion: 4% inflation:

With a 50%-50%-0% TIPS combination: 5.405% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 5.230% continual withdrawal rate.

Excursion: 3% TIPS:

With a 50%-50%-0% TIPS combination: 6.110% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 6.145% continual withdrawal rate.

Excursion: 4% inflation and 3% TIPS:

With a 50%-50%-0% TIPS combination: 5.440% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 5.310% continual withdrawal rate.

Excursion: 5% per year DVY dividend growth rate:

With a 50%-50%-0% TIPS combination: 5.730% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 5.635% continual withdrawal rate.

Excursion: 5% per year DVY dividend growth rate and 3% TIPS:

With a 50%-50%-0% TIPS combination: 5.755% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 5.695% continual withdrawal rate.

Excursion: 8.4% BAC dividend yield:

With a 50%-50%-0% TIPS combination: 6.085% continual withdrawal rate.
With a 60% high yield-40% lower yielding growth: 6.055% continual withdrawal rate.

Comments

This is a realistic combination. However, I would prefer better diversification of the high yielding investment in an actual portfolio. Suitable investments for income include carefully selected REITS, preferred stock, master limited partnerships.

I regard the fact that this preferred stock is callable in 5 years as a plus. It fits in with a delayed purchase strategy. I expect overall stock prices to be much lower (relative to earnings and dividends) at some point in the next 5 to 10 years. Dividend yields will be much more attractive. If so, you may be able to lock in a 6% continual withdrawal rate (plus inflation) directly.

I used 2% TIPS in my basic study because it is difficult to examine dividend reinvestment otherwise. A better approach is to reinvest in high yielding dividend payers. I simulate this effect by looking at 3% TIPS.

A higher inflation rate effectively lowers the dividend growth rate. Its effect is to reduce the inflation adjusted withdrawal rate. This is consistent with my standard suggestion to keep withdrawals down to 5.0% to 5.5% (plus inflation) during the first five years just in case there is a flaw in my analysis. [I make this suggestion for all new research findings, regardless of the quality of a study.]

A small reduction in DVY’s growth rate can be significant. Worst case, I expect it to match the 5% (nominal) per year increase of the S&P500 dividend. Early indications have been that it has been growing faster than 6% per year. A minor change in BAC’s dividend yield has little effect.

Have fun.

John Walter Russell
June 20, 2008

UPDATE

The BAC preferred has an 8.2% interest rate. It produces a continuing withdrawal rate of 6.000%. For an 8.5% interest rate, consider Citigroup.

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