Dividend Baseline

Here is a baseline for dividend strategies.

It dramatically outperforms fixed allocation, liquidation strategies.

S&P500 Baseline

Here are the ingredients of the total return of the S&P500:

Historically, the dividend yield has been 4% to 5%. Today’s low dividend yield is unusual.

The S&P500 nominal dividend growth rate has been remarkably stable at 5% per year since 1950 (actually, since the 1940s).

The Investment Return is the sum of the initial dividend yield and the dividend growth rate.

Historically, inflation has averaged between 3% and 4%. We subtract this amount to adjust for inflation.

Long-term, throughout the twentieth century, multiples (P/E10) increased by almost 1% per year. This is the Speculative Return.

Using these numbers, we calculate the nominal long-term Investment Return as 9% to 10%. We add the 1% Speculative Return to calculate the nominal long-term total return of the S&P500 index of 10% to 11%. We subtract 3% to 4% to calculate the real long-term total return of the S&P500. It is between 6% and 8%. Historically, the actual real, annualized, total return of the S&P500 was 6.5% to 6.8%.

My Dividend Baseline

If we were to purchase every stock in the S&P500 index that pays dividends and none of the others, we would receive exactly the same dividend amount at the same dividend growth rate. This would increase our initial dividend yield.

[Technically, this is an approximation. It is not exactly true. Some companies add new dividends. Others stop paying dividends.]

Today’s S&P500 dividend yield is just below 2%. A reasonable dividend baseline has a yield of at least 3%. It retains the S&P500’s 5% per year nominal dividend growth rate.

With a dividend strategy, you do not sell shares to increase your income. There is no Speculative Return adjustment to the income stream.

There is still a 3% to 4% adjustment for inflation.

The dividend baseline has a 3% to 4% initial dividend yield. The nominal dividend growth rate is 5%. The real dividend growth rate is 1% to 2%.

My Income Stream Baseline

I brought up my TIPS Income Stream Allocator B. I used 2% TIPS. I allocated 80% to Stock A and 20% to TIPS and 0% to Investment B.

I discovered that an initial Stock A dividend yield of 3% supports continual withdrawals of 3.95% of the initial amount (plus inflation).

I discovered that an initial Stock A dividend yield of 4% supports continual withdrawals of 4.95% of the initial amount (plus inflation).

Comparison of Dividend and Liquidation Strategies

Using my Super SVTVR L calculator, I determined what is needed for a fixed allocation, liquidation strategy to provide a comparable, continuing income stream. I set the Year 30 balance equal to 100% of the initial balance (plus inflation). I used 2% TIPS.

To match a 4% return with an 80% stock allocation, valuations have to drop from today’s P/E10=28 to P/E10=16. We can equal this with a dividend strategy provided that we can start with an initial dividend yield of 3%. Doing so is easy, even at today’s valuations. For example, the oldest dividend ETF (exchange traded fund), DVY, currently yields 3%.

To match a 5% return with an 80% stock allocation, valuations have to drop all of the way down to P/E10=13. We can get as much today provided that we are able to start with an initial dividend yield of 4%.

Have fun.

John Walter Russell
February 18, 2007