Fluctuating Dividends

I examined the income stream with wildly fluctuating dividends. It is higher than expected.

The Income Stream

I modeled a high yielding dividend stream. It started with an 8% yield. It grew at 5% per year (annualized, nominal), which is the same as for the S&P500 index.

I zeroed out the dividend amount every four years, starting with Years 5 through 8.

The average dividend yield (ignoring growth) was 4%. That is, 4% = one half of (8%+0%).

As in my earlier Income Stream studies, I neither bought nor sold any shares of stock. I used a TIPS account on the side with 2% (real) interest to steady cash withdrawals.

The Investment Return = Initial Dividend Yield + Dividend Growth Rate (annualized, nominal) – Inflation = 4%+5%-3% = 6%. This is slightly lower than the long term Total Return of the S&P500. It is higher than today’s S&P500 Investment Return because the S&P500 currently yields just under 2%.

Inputs

I collected data on Income Stream Allocator C 02 05 2007, which is TIPS Income Stream Allocator B extended to 50 years.

Stock A is a S&P500 variant. It yields either 8% or 0%, alternating in four year segments, initially at 8%. Stock A has a 5% per year (annualized, nominal) growth rate.

The Investment B allocation was zero.

The TIPS had a 2.0% real interest rate.

Inflation = 3.0%.

There were no purchases. There were no sales.

Withdrawal Rates

Stock A allocation=50%, TIPS allocation=50%.
Withdrawal rate: 4.6% through Year 50.

Stock A allocation=60%, TIPS allocation=40%.
Withdrawal rate: 4.8% through Year 50.

Stock A allocation=70%, TIPS allocation=30%.
Withdrawal rate: 4.9% through Year 50.

Stock A allocation=80%, TIPS allocation=20%.
Withdrawal rate: 4.9% through Year 24. Then it jumps to 5.2% at Year 25.

Stock A allocation=90%, TIPS allocation=10%.
Withdrawal rate: 4.8% through Year 17. Then it jumps to 5.1% at Year 16 and grows.

Analysis

I was able to maintain a withdrawal rate of 4.9% of the original balance (plus adjustments for inflation).

This is higher than might be expected. It is higher than the high yielding investment’s average dividend yield. It is also higher than the portfolio’s average yield (dividends plus interest).

The growth was only 2% per year, on average, after adjusting for inflation (real). But the growth is related to the 8% initial dividend yield, not the average dividend yield. Smoothing the cash flow shifts money from both the present and the future in the early years before there has been much growth. It shifts money strictly from the future in the later years after there has been considerable growth.

Have fun.

John Walter Russell
March 6, 2007