Income Stream Insights

I have used the Income Stream Allocator to look at a variety of conditions. Here are the key insights.

The Income Stream Allocator

The Income Stream Allocator is a simple spreadsheet program. You enter the initial dividend yield and nominal growth rates for two investment types (Stock A and Investment B). You enter a TIPS interest rate (real), the inflation rate and initial allocations. Then you vary each year’s deposits (i.e., negative withdrawals) and withdrawals (i.e., positive withdrawals) from the TIPS account to produce a steady income stream.

There are no stock sales or purchases, only additions and subtractions from the cash management (TIPS) account. You specify only the initial allocation. Allocations vary with time. Often, the best decision is to start with nothing in the cash management (TIPS) account, adding to it in the earliest years and removing money from it in later years.

Although simple, this spreadsheet leads us to some powerful insights.

Results

Here are my findings:

1. Using the spreadsheet leads to a dramatic improvement in withdrawal rates.
2. The failure mechanism is understandable and gentle.
3. Having a high initial yield is important.
4. Having a growth kicker (using a blend) helps a lot.
5. You can capture most of your portfolio’s investment return.
6. Investment return comparisons favor a higher yield when using only one investment type.
7. Investment return comparisons show that a growth kicker needs extra growth. A simple one-to-one trade off with the initial yield is not enough.
8. The optimal initial allocation is not immediately obvious.
9. There is always an advantage if you manage the cash (TIPS) account to steady withdrawal amounts. This is not only true in terms of price fluctuations. It is true even if dividend amounts fluctuate wildly.

These are my most important findings:
1. It is best to use a blend. That is, use a combination of investments, one with a high initial yield and another with a high growth rate.
2. Often, perhaps always, the best initial TIPS allocation with a blend is zero.

This is what you should do:
1. Make a spreadsheet (or download the Income Stream Allocator from my Yahoo Briefcase).
2. Determine the withdrawal rate.
3. Determine the allocation.
4. Update from time to time.
5. Make adjustments.

The hardest part is estimating the (nominal) dividend growth rates accurately. As a reference, the S&P500 dividend growth rate is 5% per year (annualized, nominal).

Have fun.

John Walter Russell
March 7, 2007