Dividend-Based Strategies starting January 14, 2007.

Updated February 25, 2007.

The Delayed Purchase Concept

Dividend based strategies provide a continual, growing income stream. They start at a low percentage of the original portfolio balance. The failure mechanism is gentle.

Liquidation strategies provide a higher initial income stream. They can run out of money in a finite number of years. Studies usually report 30-year withdrawal rates. The failure mechanism is abrupt: portfolio bankruptcy.

The delayed purchase concept is to start with a liquidation strategy and later switch to a dividend based strategy when conditions are right.

The Delayed Purchase Concept

Dividends and the Gordon Model

Dividend yields vary all over the place because prices vary. Prices depend upon current human perceptions. Dividend amounts are stable. Dividend amounts depend upon business activity.

A retiree can reasonably expect to see his initial dividend amount grow by 2.8% each year in addition to inflation.

Dividends and the Gordon Model
Edited Dividends and the Gordon Model

Retiree Needs

A retiree needs a steady income stream that grows faster than inflation. He needs an income stream that is isolated from the whims of the market. He needs income that lasts indefinitely.

Dividend based strategies satisfy this need.

Retiree Needs

S&P500 Dividend Growth

The best way to characterize S&P500 Dividend Growth is to make no adjustment for inflation. The best time period to use is post-1950. The best rate to use is from 4.8% to 5.0% per year.

S&P500 Dividend Growth

Using the TIPS Income Stream Allocator B

I have built a spreadsheet to help with income portfolios. This tells you how to use it.

Income Stream Allocator
Using the TIPS Income Stream Allocator B

Income Stream Allocator Examples

I have run some numbers. They are impressive. Dividend strategies offer a tremendous potential.

Income Stream Allocator Examples

Dividend Based S&P500 Allocation

I am creating a baseline with my TIPS Income Stream Allocator B. Based on today’s S&P500 dividend yield, which is less than 2%, the best S&P500 stock allocation is zero.

Dividend Based S&P500 Allocation

More Income Stream Allocator Examples

I have collected another set of examples using my TIPS Income Stream Allocator B. I selected two holdings from the Morningstar Dividend Investor. I wanted to translate optimistic, but realistic, estimates of dividend yields and growth rates into information about income streams.

I included a sensitivity study related to income stream shortfalls.

More Income Stream Allocator Examples

Botched Early Retirement Special Example A-1

Suppose that you retire early using a dividend strategy. Suppose that your investments do much worse than you had expected. You require a continual income stream of 5.0% of your initial balance (plus inflation).

Going back to work for 5 years solves your problem.

UPDATE (February 16, 2007): Special Example A-2

Withdrawing 4.0% of the original balance (plus inflation) for the first seven years accomplishes the same goal. Download the details from the Allocators folder in my Yahoo Briefcase. It is a Microsoft Word document. It is the Special Example A-2 file.

Botched Early Retirement Special Example A-1

Dividend Baseline

Here is a baseline for dividend strategies.

It dramatically outperforms fixed allocation, liquidation strategies.

Dividend Baseline

Dividend Growth versus Liquidation

Early retirees should adopt dividend strategies. They are vastly superior to the traditional, fixed allocation, liquidation strategies that depend on capital appreciation.

Dividend Growth versus Liquidation

Capturing the Investment Return

Dividend strategies are best. They allow you to capture the investment return.

Capturing the Investment Return
Capturing the Investment Return Follow Up

Initial Yield versus Dividend Growth

I have compared several combinations of the initial dividend yield and dividend growth rate while keeping their sum (the Investment Return) constant. In terms of generating an income stream, starting with a higher yield is better.

Closer examination reveals that a faster growth rate necessarily leads to capital appreciation. This clouds the issue. There is no clear cut winner.

Initial Yield versus Dividend Growth