Capturing the Investment Return Follow Up

In an earlier article, I reported that dividend strategies allow you to recover the Investment Return. This turns out to be the Investment Return of the overall portfolio, not the stock dividends by themselves.

Additional Data

I collected additional data with initial dividend yields of 3%, 4% and 5% and nominal dividend growth rates of 6%, 8% and 10% per year. Using my TIPS Income Stream Allocator B spreadsheet, I allocated 60% to Stock A, 40% to TIPS and 0% to Investment B. I set the TIPS (real) interest rate at 2.0%. I assumed 3.0% inflation. I adjusted TIPS withdrawals to maintain a steady income stream (real, after adjusting for inflation).

Here are my results:

Initial dividend yield: 3%
Stock A dividend growth rate: 6% per year (annualized)
Withdrawal Rate: 4.4% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 6% per year (annualized)
Withdrawal Rate: 5.2% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 6% per year (annualized)
Withdrawal Rate: 6.1% (plus inflation).

Initial dividend yield: 3%
Stock A dividend growth rate: 8% per year (annualized)
Withdrawal Rate: 5.1% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 8% per year (annualized)
Withdrawal Rate: 6.1% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 8% per year (annualized)
Withdrawal Rate: 7.0% (plus inflation).

Initial dividend yield: 3%
Stock A dividend growth rate: 10% per year (annualized)
Withdrawal Rate: 5.7% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 10% per year (annualized)
Withdrawal Rate: 6.7% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 10% per year (annualized)
Withdrawal Rate: 7.8% (plus inflation).

You can download a truncated version of these spreadsheets from my Yahoo Briefcase. It is the “Income Stream Pictures G” file in my “Allocators” folder.

Yahoo Briefcase

Calculations

My original analysis failed. I used Stock A yields and growth rates by themselves.

I have adjusted my analysis to incorporate the portfolio as a whole.

The Investment Return equals (0.6*the initial dividend yield of Stock A + 0.4*[the 2% real TIPS interest rate + the 3.0% inflation rate]) + (0.6*the nominal growth rate of the Stock A dividends + 0.4*the growth rate of TIPS (which equals the 3% inflation rate) – the 3.0% inflation rate.

[TECHNICAL DETAIL: This is mathematically equivalent to using an inflation adjusted, real, initial dividend yield of (0.6*[the initial dividend yield of Stock A – the 3% inflation] + 0.4*the 2% real interest rate of the TIPS) plus a dividend growth rate of 0.6*(the nominal dividend growth rate of Stock A).]

Here are the real Investment Returns:

Initial dividend yield: 3%
Stock A dividend growth rate: 6% per year (annualized)
Overall Investment Return: 4.4% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 6% per year (annualized)
Overall Investment Return: 5.0% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 6% per year (annualized)
Overall Investment Return: 5.6% (plus inflation).

Initial dividend yield: 3%
Stock A dividend growth rate: 8% per year (annualized)
Overall Investment Return: 5.6% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 8% per year (annualized)
Overall Investment Return: 6.2% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 8% per year (annualized)
Overall Investment Return: 6.8% (plus inflation).

Initial dividend yield: 3%
Stock A dividend growth rate: 10% per year (annualized)
Overall Investment Return: 6.8% (plus inflation).

Initial dividend yield: 4%
Stock A dividend growth rate: 10% per year (annualized)
Overall Investment Return: 7.4% (plus inflation).

Initial dividend yield: 5%
Stock A dividend growth rate: 10% per year (annualized)
Overall Investment Return: 8.0% (plus inflation).

Comparisons

With 3% initial dividend yield

Stock A dividend growth rate = 6% per year
Actual 4.4%
Overall Investment Return 4.4%

Stock A dividend growth rate = 8% per year
Actual 5.1%
Overall Investment Return 5.6%

Stock A dividend growth rate = 10% per year
Actual 5.7%
Overall Investment Return 6.8%

With 4% initial dividend yield

Stock A dividend growth rate = 6% per year
Actual 5.2%
Overall Investment Return 5.0%

Stock A dividend growth rate = 8% per year
Actual 6.1%
Overall Investment Return 6.2%

Stock A dividend growth rate = 10% per year
Actual 6.7%
Overall Investment Return 7.4%

With 5% initial dividend yield

Stock A dividend growth rate = 6% per year
Actual 6.1%
Overall Investment Return 5.6%

Stock A dividend growth rate = 8% per year
Actual 7.0%
Overall Investment Return 6.8%

Stock A dividend growth rate = 10% per year
Actual 7.8%
Overall Investment Return 8.0%

Remarks

The comparisons show excellent agreement. This is much closer than I would have expected, considering the need to use mathematical approximations.

Even today, it is relatively easy to generate a continuing income stream of 5% of the initial balance (plus inflation). Reaching 6% is straightforward.

The need to use TIPS to manage the cash flow drags the Investment Return down to the level of a 60% stock – 40% TIPS portfolio. A better solution might be adding a high yield Investment B. It would still be necessary to include the TIPS account. It would be smaller. It would have less of an influence. Investment B would give the overall portfolio an income boost for at least a decade.

Have fun.

John Walter Russell
February 22, 2007