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I see a lot discussed about using cash and bonds in retirement. I’ve wondered why using portfolio income (interest and dividends) isn’t discussed to supplement or as an alternate to withdrawals.
I’ve thought about using income temporarily during market downturns to reduce cash and bond allocations.
What do you think and who has experience with this strategy?
Wow, what a response! Thanks to all for sharing your experience and thoughts. Your support as a community is appreciated!
Some additional detail on my developing principle of strategic income (from a total return portfolio) …
I’ll credit my late father for the idea. In his case, he used a small collection of utility stocks to provide dividends that supplemented his SS and pension. He lived a comfortable lifestyle and maintained his networth during his 30-year retirement (’88-’18). Fairly conservative, his stocks didn’t grow much (and didn’t show much volatility), but it got the job done.
My portfolio is developing in early retirement as a total return strategy and selling appreciated assets in a tax efficient manner. Based on our budget that means taking traditional IRA distributions first using the 10 & 12% brackets, then taxable using LTCG 15%, and finishing with Roth conversions to fill the 22% bracket (or IRMMA limit when that applies) as our plan is still showing 24% tax rate at the end. OCDs make be part of the picture later as well. In the end, without children, my goal is to leave a financial legacy in the form of an endowment. We’ve started this with a donor advised fund (DAF) a couple of years ago.
While the portfolio is total return, it does have 1-2 years cash (some in the traditional IRA until needed to avoid a little tax drag), ~6 years of bonds, and the remainder in equities. Each bucket has several holdings as I am enjoying exploring and researching different asset styles and respective performance within each bucket.
Some of your experiences about simplifying later in life and shifting to a more income-oriented portfolio make a lot of sense to manage cognitive decline risk. I’ve also started developing an investment policy to capture all of this to share with my wife and financial advisor/planner.
In summary, thanks again for all the feedback, I’m more comfortable that periodic short-term use of portfolio generated income is a sound strategy and could help extend more traditional cash/bond “ballast” assets during extended market depressions.
For many years I owned oil royalty trusts which typically returned 10% tax free based on the value of the stock. But I wouldn’t recommend the strategy now.
About ten years ago in this blog there was a discussion of QYLD. I have since learned about GPIQ which may have an added benefit of capital appreciation. Also, a few weeks ago a friend told me that his financial advisor has him following this strategy with a large percentage of his investments for steady income. I have a smaller position than this in my Roth IRA. Regardless, I learned about it here and depending on your worry that the strategy may stall, since 2020 the two positions have returned a steady dividend of between 10% and 12%. I could be using this as income, but I don’t need the income yet, so I’ve been reinvesting the dividends in SCHD and VYMI which are high dividend stock ETFs with low expenses.
I am currently experimenting with a simple three fund portfolio that historically (based on portfolio visualizer) provides around 8% growth with 3.3% dividend/interest income. I have been a total return investor all my life and had not paid much attention to dividend income (it has always been reinvested). However, as we are starting to enter into our 80s, I am experimenting with different income strategies to see if it can help reduce the need for decision making (to mitigate possible cognitive decline in the future).
In our situation, we have sufficient lifetime income (from SS benefits and annuity income) to cover all our essential expenses and much of our discretionary spending as well. We currently need around 3% of our portfolio annually for travel, gifting, and charitable donations. The above portfolio appears to meet that goal (over a long term). Currently, I have an account that started out with $100K for experimentation with this portfolio structure and has been operating (untouched) for the past 30 months so far. The mix of funds is 30% growth equity (S&P 500), 30% US Div 100 index equity, and 40% bond fund (Fidelity Strategic Income). All equity gains are reinvested while all dividend and interest are “withdrawn” and put into a reserve fund. I am 30 months into a 3-year experiment where I have been tracking the monthly gain and dividend/interest income. So far, this model portfolio has had 11% annual growth and 3.8% annual income for a total return of 14.8%. The last 2.5 years have been relatively good but the returns are in line with historical outcomes. While the month-to-month income is quite variable, I simulate the monthly income withdrawal by removing such assets from the reserve fund, which was initially “seeded” with several month “income” as a buffer. Then all dividend/income from the funds are distributed to the reserve fund to replenish the balance. After 2.5 years, the original 60/40 asset allocation has shifted to 70/30 (implying the possible need to rebalance every 3rd year or so). If I were to start with a 50/50 asset allocation, it could increase the annual income but with a slower growth, while increasing the time frame when rebalancing may be needed. Since the income from this portfolio is mainly for discretionary spending, there is flexibility in both withdrawal and spending.
I forgot to mention that half our assets are in Roth accounts and that a 3% withdrawal rate satisfies our RMDs as well. In six months when this experiment will come to a close, I will do an analysis of the monthly cash flow, play out a few “what if” scenarios, and then decide if I want to transition our full portfolio to this structure.
Outside of this I still have another 20% (equivalent – not counted as part of the 100% above) in alternative assets. These assets include bitcoin and precious metals, which I consider as part of growth and not income.
Personally, I would not consider doing this earlier in retirement. I do worry about what might happen if I am no longer here or cannot carry out our portfolio management in the future. I have interviewed several financial advisors and also have considered a robo-advisor with once-a-year meetings. Those are still options. But so far, I am leaning toward just simplifying the portfolio management process if “enough” is “good enough.”
We (my wife and I) begin taking distributions (dividends and capital gains) from our mutual fund accounts (all taxable) for a group of expenses that occur around the winter holidays. Christmas gift-giving, long term care insurance premium, estimated federal and state tax payments, property tax payment, and a few final charitable contributions all roll around in December and January. These bills total about $35,000. In September, we set the distributions of dividends and capital to automatic from Vanguard, T Rowe Price and Dodge and Cox accounts. Along with one other source of income (a retirement benefit from a former employer), we are able to cover all of these bills in this way. In January, we reset the distributions to reinvest. Weather or not we reinvest the distributed dividends and capital gains from the funds or withdraw them, we still pay income taxes on them. We call the distributions our “windfall account,” and managing our investments this way has worked rather well for us.
I distinguish between portfolio income and guaranteed income. BILL Bernstein suggests counting half of equity dividends toward retirement liabilities, based on historical experience. I use a TIPS ladder for the rest.
As for withdrawals, I spend taxable income, including dividends and interest, first. Since I owe taxes on it anyway, I might as well spend it before drawing from tax-advantaged accounts. I don’t expect specifically change that strategy during market downturns.
Good to note the distinction. I hadn’t heard that guidance from BB so glad you shared it.
For income to supplement our SS and my small pension, we use muni bonds and real estate private equity qtly distributions. The muni bonds are held to maturity or if called. The capital in each bond when called is reinvested into another A+ rated or higher muni bond, usually in the state we live in. I am finding A+ bonds with yield to worst in the 5.1% area, which are bought slightly below par, with a call date in the 2034-2036 range. We don’t touch our non-qualified money, but no longer reinvest the distributions anymore and it just oes into tax free accounts. IRA/ROTH IRA distributions are reinvented.
I don’t own the classic dividend stock or ETF, but some of the stocks and ETFs I own do pay dividends, most of which are qualified. I stopped reinvesting the dividends and now have the cash available if needed. It’s a great way to have access to cash without liquidating an investment. I think it may be a great strategy for you.
I have a total return portfolio but the first money I spend is the dividends kicked out. If more is needed then I sell the fund with highest basis.
A tax client’s income consisted of a railroad pension and about two dozen dividend paying stocks in a non-qualified brokerage account. It worked out well for these folks, as those qualified dividends are treated the same as long term capital gains, which in their case equaled no tax liability at all.
Having said that, look out for the risks mentioned in the comments below. An alternative to owning dividend paying stocks would be to use target date maturity bond funds. These funds are best held in an IRA due to ordinary income taxation. While I’m not sure if you could quite match Ken’s results (see his comment below), the target maturity bond fund seems like less work and less risk. Also, if you hold the funds to maturity, you don’t have to worry about value fluctuations.
I believe the poster is looking for some addition income to supplement his income from other sources. In that case, Target Date Maturity bonds ( inside an IRA) wouldn’t be appropriate for that particular need.TDM bonds for long term investments are a nice safe bet but shouldn’t be used as an income stream. In fact, I believe the interest needs to be invested to achieve the expected YTM.
I see what you’re saying and agree with you.
We have been living off Social Security and dividends for the past 6 years. Our portfolio is 70% dividend-paying stocks, some preferred stock ETFs, and 30% growth stocks and ETF’s. We own no bonds. We have had bond funds in the past and never made any money with them. When the stocks went down, so did the bonds.
Our dividend portfolio is made up of dividend kings and aristocrats. Paying dividends and growing their dividends every year for 20+ years. Having companies that have been paying and growing their dividends for 20-50 years proves that even though the stock price and our net worth bounce around, our dividend income stays steady through thick and thin. We learned that it’s not your net worth that matters as it fluctuates with the market; it’s what income your net worth can produce.
We don’t need all the dividends it produces, so a portion of the dividends gets reinvested back into our dividend-paying stocks so that our dividend income keeps growing.
We buy our dividend stocks and funds when the market or stock is down. The stock price has to be below the mid-point of its 52-week price range. This results in a higher yield. We average a 5.4% yield.
We use a checklist of our buying rules to help take emotions out of the process. It doesn’t always guarantee we won’t end up with a stock that cuts its dividend ( a sure sell signal for us), but it keeps us directionally correct.
It’s always interesting to hear people talk about how long their money is going to last in retirement. We have yet to sell a single share of stock to fund our retirement, and our monthly income has kept growing every year.
If you don’t need all of the dividends your portfolio produces, I would argue that you are paying more taxes than you need to, and taxes are one of the bigger expenses in retirement. Just like you don’t want RMDs to be more than you need, I don’t think you want your dividend income to be more than you need.
The Dividend payers are all in our IRA’s. We take some of the excess cash out of the IRA’s and put it into our taxable brokerage accounts, emergency fund or vacation budget. We also do Roth conversions. We monitor our tax rate to stay in the lower brackets.
Based on our projections, our RMD’s will be slightly more than our current withdrawal to supplement our Social Security.
With all the issues surrounding Social Security right now, possible cuts or going away altogether ( possible but not probable ), any overages in our RMD’s will make up for the cuts to SS if they occur, keeping taxable income controllable.
And then there is always a qualified charitable distribution (QCD), which can be a great way to reduce required minimum distributions and taxable income and optimize the tax benefits of giving.
No plan is 100%, so we monitor and adapt as necessary.
Stocks go down and still pay dividends. Why avoid bonds because they may go down if you are an income investor? Bonds would still pay interest while going down in value?
Based on the life expectancy that runs in my family and God willing, I have another 30-35 years to go. The probability that stocks will outperform bonds over those 30-plus years is high.
I can sit through market drops knowing the odds are high that our dividend income will remain steady and wait for the market to recover. Dividend kings and aristocrats have paid and increased their dividend every year for 20-50 years, and have gone through many market downturns during that time without missing a payment. If these high-quality stocks all tank, I am sure that bonds are going to tank also.
And with our country’s level of debt being greater than our GDP, how safe are government treasuries and bonds?
So I am wondering where the risk is? I would love to hear and consider what others’ opinions are.
Thanks
This reminded me that my father used to talk about “widows and orphan” stocks – steady reliable dividend producers appropriate for investors who required safety and secure income. Mark makes some very good points. One thing I would add is that many of the higher dividend paying portfolios I have seen are very concentrated in one or two companies, often as a result of employment and employee stock plans. They often paid in the 4 or 5% range, much higher than an SP500 or Dow portfolio.
Actually there was quite a discussion about that income stream not too long ago.Search “dividends “ here and a few will pop up.
My first thought on why you don’t hear much about living off portfolio income: dogmatic opposition. Total return is the industry’s gold standard, and for sound reasons, including tax timing and the “free money” illusion of dividends. But that can leave income-based approaches dismissed out of hand.
Your idea of spending interest and dividends during downturns, rather than selling, makes sense to me. It’s a practical way to ease sequence-of-returns risk and may let you hold less in cash and bonds. Two things I’d watch. One is reaching for yield, which can mean taking more risk than you intended. The other is that dividend income can fall just when you’d be counting on it, since companies often cut payouts in a downturn. Bond interest tends to hold up better, but it’s worth testing your plan against a weak stretch for dividends.
I’m a pragmatist: if it works for you, go for it.
Mark, I’m a proponent of the total return approach. Respectfully, I’d also add that using dividends during our market downturn, I think plays into the idea of “free money.” Thus, the debate between total return and dividend paying stocks as your source of spending money. Even though dividends are steadily being paid out during a market downturn, they may be produced from stocks from falling share prices. Does that make sense? Eventually, both dividend paying stocks and growth stocks are expected to recover during the inevitable market upturn.
Andy, I agree. If I were drawing down my own portfolio, I’d use a total return approach. That said, I’m not dogmatic about it. The dividend approach may be suboptimal, but I understand its appeal. Long-standing dividend payers tend to be less volatile, and when you pair that with fairly steady cash flow, it’s a compelling proposition for many people drawing on retirement accounts.
Optimization only works if you can also sleep at night. During a prolonged downturn, focusing on dependable cash flow rather than net worth probably makes for better sleep among those with a dividend-first mindset.
Well said, great summary. I’m not dogmatic either. Total return is my planned approach, but as I’m not yet retired (next year?) I haven’t put in practice. I’m hoping to enjoy the process and sleep-filled nights.
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