Are dividends not a good approach when deciding on investing?

LHW99

Linton said:

LHW99 said:

Linton said:

Prism said:

ColdIron said:

I'm not so sure about this. Dividends hold up better than share prices, certainly in the short term as the directors choose the payout and shareholders don't like dividend cuts. During the Covid period where there were dire warnings about dividend cuts my analysis shows no drop in my income whatsoever. Obviously there is a limit to how long this can be maintained but it does provide a useful resilience to those relying upon them

Bottom line: If you are young ignore dividends, focus on total return

What I meant was that by relying more on dividends, should/when they get cut, it has a bigger impact on a strategy than lets say something like regular sales and withdrawals which just carries on regardless. It requires a decision on how much to sell to top up the dividend loss and an understanding of how that might impact future dividends from a lower number of units.

I still reckon that sell what you need from a balanced portfolio is simpler and more effective for most.

In my experience, provided your portfolio is well diversified, cuts in dividends is less of a problem than say major falls in equity prices  Yields can rise and fall but generally  that is more a function of changes in value of the shares than changes in size in £ terms of the dividend/interest. Rather like bonds.

And in particular, not to "chase high yield". I began positioning our SIPP portfolios around 15 years ago with an aim of providing a specific level of dividend income. I have around 15 funds, with only 1 specifically high income, the remainder mainly below 4% yield currently, with a couple of low yield, growth focussed funds which can be swapped to income generating if appropriate. Overall dividend income % has risen over time and is now 4.2% of the current capital value. Works for us, and will / should leave something when we go for the children / grandchildren.

I do aim for fairly high yield.  It is currently about 6.5%, mainly because capital values have fallen thanks to increased bond interest rates.  However I run separate growth and high income portfolios with the corresponding and very different objectives and hence very different structures.  So the growth portfolio is available to shore up the dividend one should it ever be necessary. So far after more than15 years it has not beyond dealing with inflation.

Ours is not specifically separated into growth vs income as far as SIPPs go, and I have aimed for an overall nominal average yield from the funds of around 3%. As time has gone on, and capital values have risen, so have the monetary value of the dividends, so that the returns from early purchases are now a much higher percentage of the cost price of those units. The content / proportions of the portfolio does change over time, but very slowly. The oldest is an IT where a holding was first purchased in 2007, and there are a number dating from 2013-16, as well as more recent investments.

gm0

This discussion comes up regularly and there is often an element of cross purposes discussion.

The "taking of returns" (as dividends paid vs capital share prices (market valuations) growing via earnings per share and buy backs).  Which is not a huge deal as has been restated upthread.  Different companies and countries and tax environments.  Plumbing.

The filtering and selection of stocks (or funds) to invest in based on their historic and current behaviours in respect of "dividends" i.e. more or more consistency being good and less or none being bad.  Which is demonstrably nonsense as a holistic approach to stockpicking the entire portfolio.  Sweeping up as it does - terrible businesses and some solid cash generative ones but in other dimensions - still risky, cyclical or unattractive for other reasons. Tobacco, Oil, Mining etc.  And missing some vital (for 20 years or more) growth stories.

So

- Income Fund portfolio
- High Yield Portfolio etc.

Are just stock lists.  You like the selection criteria and list it generates or not.  I generally do not.  But I would use such a fund as an equity investment in a heartbeat to round out a portfolio if it contained ingredients I wanted to bring up to weight and needed to based on other decisions.  And I was confident of the mandate, fund house and the demonstrated history of how the fund is managed.

But no portfolio discussion is EVER independent of "purpose".

All sorts of odd portfolio shapes can be purposeful depending upon what you hope to achieve and what risks you are content to carry vs wish to attempt to manage.  (c.f. Permanent Portfolio).  Ridiculous - unless you care about what it is trying to prevent happening to you as a low probability, rare, but high impact if it did event. 

If the original discussion was framed from web commentary and FIRE and USA,  Saving up for FIRE is completely different to deaccumulation. Different design issues and risks for a portfolio.   A major correction at age 30 is a golden opportunity to buy half price units.  Hopefully you get another at 40.  A major correction at age 70 is an opportunity to sell twice as many stocks each year to sustain retirement income and to threaten running out of capital before death. (Absent better portfolio design aimed at that).  Clearly the "all in" for growth 100% equities US domestic market at lowest cost" story as may suit the former (if US based and working in dollars saving for FIRE) may not be at all appropriate to the latter case.

So examine their frame of reference - ignoring for the moment the US growth and tech bull run of recent decades.

If you can "grow" or otherwise harvest a large enough pot from work then  "income generating" investments are an annuity - literally if they are a TIPS ladder (US Index Linked Treasuries). Or a bag of stocks and bonds via funds which spit a yield and vary in capital value over time.  With whatever level of risk (to the payments continuing - sovereign default, widespread corporate wipeouts is attendant).  Capital revaluation cycle of share prices is a dimmer concern. Volatility of share prices can be "looked through" to long term asset class returns provided income can be  sustained without major sales. The next generation can continue the same mix - or select a different position on the risk dial.

But now imagine a retiree who wants income (from total return as capital growth and from dividends if any such stocks are held in income unit funds, (and bonds and MMF and whatever).  A retiree who plans to deplete their assets over 40 or so years. In contrast to our financially independent living off yield person - they are very focused on sequence of return, short term volatility in capital value along the way - as assets are sold consistently.  Any income component of (total return) arriving will offset annual sale.  This is secondary to overall asset mix and sequence planning but it is still useful as a possible tool for portfolio design.

This case - (the capital depleting retiree) then leads you to a diversification argument where any tilt away from global markets as an active filtering or stock picking bet becomes justifiable on a handful of measures

- Belief that it will generate excess returns vs other choices - more alpha = more total return = income under the curve of capital + income over time for the retiree (or leftovers for heirs)

- Reduction in risk carried by the retiree during the deaccumulation journey.  Predicted lower volatility consistent with adequate income from return and disposals.

Sustained income "coverage" against essential income needs - whether it's gilts, money markets, or perhaps - for some people - funds of income stocks.  Sales reduced or suspended - perhaps for several years - and yet adequate income is maintained. 

Do I hold income stocks - yes - in overall global funds.  Do I use income fund units in drawdown design inside a tax wrapper - also yes,

Do I filter to hold high yield / dividend champions selectively *instead* of broader whole of market or geographic holdings. 

No - it's not a tilt I like.  I don't believe that over 40 years it will provide alpha (somewhat older "ex growth" dividend paying businesses and some I don't approve of).

And ethics aside - for my other holdings and decisions it's not a useful fund for me to add.

No free lunch.  A lot of things will work sometime.  Or some of the time.  Including this.

adindas

Good to have it as a bonus, but not as a main criteria. In many instances they just return your own money. Worse because those acute traders who just hold the stock for a few days are also rewarded, getting dividend using your money.

dunstonh

adindas said:

Good to have it as a bonus, but not as a main criteria. In many instances they just return your own money. Worse because those acute traders who just hold the stock for a few days are also rewarded, getting dividend using your money.

When a share/unit goes XD, the price goes down (ignoring other influences),   So, how are they getting rewarded?

jamesd

[Deleted User] said:

For example, the so-called SWR seems very sub-optimal, especially when combined with a state pension.  

Sub-optimal how?

SWRs vary depending on the drawing rules used. Around 3.5% increasing with inflation using the 4% rule approach or around 5% usually but not always increasing with inflation using Guyton-Klinger instead.

GK is likely to do a better job of getting all of the money used because it's less cautious due to its ability to vary. Both are the best that can be done if the worst past sequence happened and you're likely to do better. You can redo the SWR calculation whenever you like.

MK62

[Deleted User] said:

jamesd said:

[Deleted User] said:

For example, the so-called SWR seems very sub-optimal, especially when combined with a state pension.  

Sub-optimal how?

SWRs vary depending on the drawing rules used. Around 3.5% increasing with inflation using the 4% rule approach or around 5% usually but not always increasing with inflation using Guyton-Klinger instead.

GK is likely to do a better job of getting all of the money used because it's less cautious due to its ability to vary. Both are the best that can be done if the worst past sequence happened and you're likely to do better. You can redo the SWR calculation whenever you like.

Imagine that you have retired and have 12 years to go until you receive the state pension. An SWR approach does not work very well here.

As long as you make the necessary adjustments, it works just as well in that scenario as any other....

Linton

[Deleted User] said:

MK62 said:

As long as you make the necessary adjustments, it works just as well in that scenario as any other....

Go on then, I'll bite.  What are the necessary adjustments?  To keep numbers round, why not assume a £10,000pa state pension and a £500,000 pension pot?  And how do you know that these adjustments are not sub-optimal?

You will never know would have been optimal until after the event.  How do you judge what is optimal?  Is it how rich you are on your death bed? Once you know that you are on your way to devising one which should work for you.

I believe one's strategy merely needs to be good enough so as you dont run out of money too early and dont die too early through worry.

Some people solve this conundrum through a highly structured strategy like Guyton Klinger.  Personally after many yars experience of retirement I see fundamental flaws in the whole basis of the calculation of SWR.  Furthermore I do not understand exactly how with GK one decreases expenditure fast enough in the bad times to have a useful effect or increases expenditure beyond the point at which one's lifestyle warrants it.

So the approach I follow is to have a large buffer large enbough to outlast almost any period of falling markets whilst maintaining a steady standard of living matching that prior to retirement. 

MK62

[Deleted User] said:

MK62 said:

As long as you make the necessary adjustments, it works just as well in that scenario as any other....

Go on then, I'll bite.  What are the necessary adjustments?  To keep numbers round, why not assume a £10,000pa state pension and a £500,000 pension pot?  And how do you know that these adjustments are not sub-optimal?

I said an SWR approach would work as well in that scenario as any other.......not whether it would be optimal or not.

At the most basic level, the "necessary adjustments" might mean simply peeling off enough, at the outset, to supply an SP "substitute" annual sum for 12 years...ie a bridge. That could take the form of a 12 year fixed term annuity, or you could invest it, hold it as cash.....whatever you are most comfortable with. So, if you put aside say eg £140k to provide that bridge, the rest is a straightforward SWR calculation (or GK or VPW or whatever method of variation you favour) for maybe 35 years on the remaining £360k.........

As others have said, there's no way to know beforehand if it'll be optimal or not though......but that's the same for any drawdown strategy.

MK62

[Deleted User] said:

Linton said:

Some people solve this conundrum through a highly structured strategy like Guyton Klinger.  Personally after many yars experience of retirement I see fundamental flaws in the whole basis of the calculation of SWR.  Furthermore I do not understand exactly how with GK one decreases expenditure fast enough in the bad times to have a useful effect or increases expenditure beyond the point at which one's lifestyle warrants it.

So the approach I follow is to have a large buffer large enbough to outlast almost any period of falling markets whilst maintaining a steady standard of living matching that prior to retirement. 

You are lucky but some people don't have a big enough buffer.  I personally think you need some guidelines to work out whether you have a buffer.  But very much agree that they are flawed.  For example, if some retired last year with a £100,000 pot, drew a "safe" 4% (so £4,000 per year) and inflation is 5% then this year they can draw £4,200 even if their pot has now fallen to £70,000.  So why can't someone retiring today draw £4,200 from their £70,000 pension pot and also be "safe"?

The word "safe" in SWR is a misnomer really.......in this context it really means a probability of success of x%, (typically 95%). What you are illustrating above is one of those other 5% scenarios........statistically unlikely, but certainly possible.

Personally I think SWR should really be an abbreviation for Starting Withdrawal Rate.......you need to recalculate it periodically.........my view is that it helps to think of it not as being year 2 of a 30 year retirement, but year 1 of a 29 year retirement......and so on.

Linton

[Deleted User] said:

Linton said:

You will never know would have been optimal until after the event.  How do you judge what is optimal?  Is it how rich you are on your death bed? Once you know that you are on your way to devising one which should work for you. 

By sub-optimal I don't mean sub-optimal after the event. I mean sub-optimal based on the choices you have today.

So, for example, if you have £10,000 in cash and have been told you are certain to die in a month then deciding to spend £10,000 this month might be said to be optimal (subject to a legacy motive and the spending fitting your values, etc).  If you were told you would die at some time in the next three months then spending £10,000 in month 1 would not be optimal.  But neither would spending £1,000 per month now (again, subject to legacy motive and values).  So there will be a value between £1,000 and £10,000 per month that is more optimal whether you die in one or three months.  What that value is will depend on many things.

Yes but what is the optimal you are looking for?  What income do you want? What risks are you prepared to accept and what income are you prepared to sacrifice to mitigate those risks you are not happy to accept?

Sure, if we knew the future we could make a perfect choice with the resources available, but we dont.  We will never know when we are going to die since we will be dead.  We will never know in advance what global events will occur which will seriously impact investment returns.  So for example the strategy must acknowledge the possibility that you will live to 100+ or an n-year crash even if you then simply discount it.

It is unlikely you will satisfactorily cover every eventuatity unless perhaps you buy an index linked annuity.  Any financial risk not covered by an annuity is likely to affect your neighbours and many other people across the world far more than it affects you.

There is no perfect strategy that is optimal for everyone as attitude to risk is very much a personal matter. How risk is managed in retirement can be more important than the exact £££s.  Deciding that and then work out what income you will be able to afford in retirement may be a better approach than the reverse.