Expanded Allocator Insights A

In this initial investigation, I find that I can increase the Income Stream substantially. The reason? The Expanded Allocator is much easier to use than my Income Stream Allocators.

Comparisons

I desired to create an income stream baseline. I desired to know the minimal realistic income stream starting today.

I used Excursion A of “More Income Stream Allocator Examples” as my starting point.

“Objective: Constant high income stream to Year 30. Excursion A.This uses TIPS with a 2.0% (real) interest rate (as opposed to 2.5%)."

"Stock A: 4% plus 8% growth.
Investment B yields 6% plus 0% growth.
35% stock A/35% Investment B.
$5100+ real withdrawals, growing after Year 19, belt tightening begins in Year 7.”

“From Excursion A, the withdrawal rate starting in Year 7 was still 5.1% of the original balance (plus inflation) assuming zero growth.”

Using the Expanded Allocator, I was able to increase the REAL withdrawal amount to $5500. The rate, using identical conditions, rose from 5.1% to 5.5%.

I did not have to change a thing to get this improvement. The improvement is strictly because of the ease of use. The Expanded Allocator uses REAL withdrawal amounts as its input. The original Income Stream Allocators uses NOMINAL withdrawal amounts.

In fact, I was able reach a 5.6% withdrawal rate by changing allocations slightly. I increased the TIPS allocation by 5% and reduced the bond allocation by 5%.

Stock A: 35%.
Investment B: 30%.
TIPS: 35% ($35000 out of $100000).
Withdrawal rate: 5.6%.

Notice that Stock A has an 8% per year (nominal) dividend growth rate. I reduced this for my baseline.

Income Stream Investor Baseline

I assumed a reasonable, but minimal, dividend growth rate for my baseline condition: 5% per year (nominal). This is identical to that of the S&P500 index.

I assumed a 4.0% initial dividend yield. This is high, but reasonable, for today’s dividend oriented retiree.

Stock A has a 4% dividend yield and a 5.0% (nominal) dividend growth rate. Investment B is a bond with a 6% (nominal) interest rate and zero growth. TIPS have a 2% real interest rate.

Both of the following allocations provide a continuing income stream with a 4.9% REAL withdrawal rate:

Stock A: 65%.
Investment B: 10%.
TIPS: 25% (i.e., $25000 out of $100000 initially).

Using Stock A: 65%.
Investment B: 15%.
TIPS: 20%.
(This has a lower minimum TIPS balance, but it is almost as good.)

Conclusion

Even today’s most cautious Income Stream Investor can count on withdrawing 4.9% (plus inflation) of his original balance far into the distant future.

Have fun.

John Walter Russell
April 16, 2007