Dividend fund in taxable account during retirement, yea or nay?

[keepingitsimple]

This is the first question I have posted to Bogleheads and I’m certain it will out me as a Boglehead-newbie. But that’s okay, I suppose we all have to start somewhere. Before I post the question, I would like to clarify I am not defending the position, rather I am asking the question for guidance and opinions regarding it’s logic or lack thereof.

I have read varying opinions about investing in Vanguard High Dividend Yield Index Fund VHDYX in a taxable account prior to retirement, most of which seem to be against. However, what is the forums opinion regarding investing a lump sum (windfall) in VHDYX during retirement, in a taxable account, if the dividends are equal to the amount one wishes to withdraw annually? Could this possibly be a good position in the event of a market downturn, which might make selling off shares of say Vanguard Total Stock Market Index Fund VTSMX (to receive the same amount of income) unattractive?

My train of thought is that during a prolonged market downturn, one would have the dividend income from VHDYX without selling shares. So, at the end of the market downturn, one would still own the same number of shares. Whereas with VTSMX, one would receive some dividends but would need to sell off some shares in order to equal the dividend income VHYDX provides. I realize during a market downturn dividends may be reduced, but it seems this would be a constant for both VHDYX and VTSMX alike.

If you were in retirement, had a lump sum to invest in a taxable account (in the US portion of a three fund portfolio) and would only need income equal to the amount of dividends that VHDYX happens to provide, would you invest in VHDYX, invest in VTSMX, invest in both or do something different?

Thanks in advance to all for taking time to read and share your thoughts and opinions.

Edit: Original post edited to change incorrect ticker (VHYDX) to correct VHDYX. Thank you livesoft for pointing out the error.

[PFInterest]

when the market goes down, so will your dividend. you will have to still decide to sell shares.
only total return matters.
generally, its just less efficient.
if you dont have much income, then it doesnt matter what you do.

[jpsc]

Is it possible to just get the dividend yield instead of selling share during retirement?
if the dividend yield 4% - why sell share ?

[keepingitsimple]

Thank you PFInterest for your response. Would you mind helping me understand how it's less efficient? I'm still learning.

[keepingitsimple]

I would be grateful to learn the opinions of others on this question, if you have a moment.

[MathIsMyWayr]

You own a fraction of a company by owning its stock. Now, you have two accounts: A) your personal account and B) the portion of the market value of the company which is entitled to you. On a regular basis the company opens its safe and transfers a certain amount of money to your personal account. This is called dividend. Does the financial market notice this activity? Yes, it lowers the price of the stock because the company is worth less by the amount of the dividend paid. Does it change you net worth? No, it is like you move money from the left pocket to the right pocket. Unfortunately it does not stop there. Government also notices this activity. Any time actual money changes hands, government tends to impose tax on the transaction.

[TinkerPDX]

I think it goes something like this. Surely someone will correct me if I’m wrong.

Generally dividends are taxed as ordinary income, while capital gains are not. So tax-wise (at least at the margin), a dollar of dividend income is not worth as much as a dollar of capital gains income, after tax.

Hence less “efficient” for the shareholder to receive $x as a dividend as opposed to as an increase in share price of $x.

Companies don’t have to pay dividends. Even the companies in the “high dividend” indexes don’t. If they’d just keep the money, the shares would appreciate instead, and holders who wanted income could sell, realizing the dividend amount as an additional capital gain.

So really, by paying dividends instead, companies are costing shareholders (after-tax) money.

[Leif]

You might find interesting information from this post.

Divs and Cap Gains are killing me

In that thread I posted:

I went with tax efficient funds in taxable. That includes TSM and ITSM (EAFE) funds. Asset location matters.

Your gains are baked in at this point. My only suggestion would be to sell them if they take a significant drop, and replace them with efficient (low turnover) funds, such as tax managed and broad based index funds. If you have any stocks/funds under water you could sell them as well to offset some gains.

With tax efficient funds you have better control of your tax situation. The poster I reference above went with tax inefficient funds. The problem then become he had capital gains, so it is very difficult for him to change without paying a lot in taxes when selling his tax inefficient funds to buy those that will not give him a big surprise at tax time.

You are fortunate in that you can decide now you don't want to be that guy.

[venkman]

If you were in retirement, had a lump sum to invest in a taxable account (in the US portion of a three fund portfolio) and would only need income equal to the amount of dividends that VHYDX happens to provide, would you invest in VHYDX, invest in VTSMX, invest in both or do something different?

Most people here prefer to focus on total return, but I think it's fine in your case to use dividends. Most or all of the dividends should be qualified, so you'd be paying the CG rate on that money anyway. Dividends are more volatile than bond interest, but not as much as you might think. David Carlson had an article on this recently:

http://awealthofcommonsense.com/2018/04 ... nd-yields/

Dividends have also held up relatively well during market downturns. According to Shiller, the stock market fell more than 80 percent on a real basis during the Great Depression, but inflation-adjusted dividend levels were down just 11 percent. When stocks got chopped in half during the brutal 1973-74 bear market, dividends fell just 6 percent in that time. And since the 1960s, the annual rate of growth on dividends has never been negative over all rolling five-year periods.

If your primary goal is to generate income, I would also consider allocating some of your portfolio to a long-term taxable or muni bond fund. It will give you a similar level of income that's a bit more stable. And it will help stabilize your portfolio during a market downturn.

[Earl Lemongrab]

Generally dividends are taxed as ordinary income, while capital gains are not. So tax-wise (at least at the margin), a dollar of dividend income is not worth as much as a dollar of capital gains income, after tax.

Other than bond funds, no. First, capital gains can be either long or short term. Only the former get preferential treatment. Secondly, most dividends from stocks are qualified, meaning that they have similar tax treatment to long-term capital gains.

[bradpevans]

Thank you PFInterest for your response. Would you mind helping me understand how it's less efficient? I'm still learning.

The efficiency typically refers to "tax drag", which means you may have tax implications every year due to the dividends being paid to your account. Collected or re-invested, there is still a tax hit every year if held in a taxable. Conversely, if you hold a non-dividend paying stock, you only have tax implications when you decide to sell. If you think of "dividend compounding" it actually becomes (dividends - tax hit) compounding.

OTOH, since you plan seems to be more in the "collect and spend" you don't have this tax drag consideration.

at least that is how i think of it.

[zekevfab]

I am interested by this subject as well. As stated in some answers above, the dividend yield is less volatile than the stock prices. And now especially if you select the stocks yourself based on their dividend history (some companies like XOM have been paying dividends for decades).

I would be interested by high dividend stocks as a higher yield alternative to supplement bonds to provide some diversification and resiliency in case of prolonged recession.

[Tyler Aspect]

I am interested by this subject as well. As stated in some answers above, the dividend yield is less volatile than the stock prices. And now especially if you select the stocks yourself based on their dividend history (some companies like XOM have been paying dividends for decades).

I would be interested by high dividend stocks as a higher yield alternative to supplement bonds to provide some diversification and resiliency in case of prolonged recession.

A dividend income fund does not protect you from an economic recession. Vanguard Equity Income Fund behaved in the same way as Total Stock Market Index during the last recession.

[bloom2708]

Every stock (384) is in the Total US Stock market index (3,600) stocks.

The yield is a bit higher because High Yield owns more/different amounts of the funds that provide a dividend.

By buying High Yield (2.99% SEC yield) you are focusing a sector of the US stock market. What if the best performers are in the "other" 3,216?

When you get a dividend (in taxable) it is a taxable event for that year. If you re-invest or send the dividend to your settlement account and later to your checking account. The tax event happened.

Total US Stock index also gives you a dividend (1.83% yield today). A little bit lower. The expense ratio on Total US stock market is .04% (Admiral, VTSAX). The investor share expense ratio for Total US is .15% (same) but once you get to $10k, you get Admiral and the lower cost. The expense ratio for High Yield is .15%. .11% for selecting the dividend paying stocks (compared to Admiral). Less diversity too. What if the best/blow up stock is in the other group and doesn't yet pay a dividend?

So you get a tax drag (pay a bit more tax as the dividend is higher) and you get an expense ratio drag. They seem small/tiny, but over 30 years. Well, the little stuff matters.

You can have both Total US and High Yield. Then you are tilting again to the "high dividend" stocks. Same story. More tax, higher expense ratio.

[oldcomputerguy]

I think it goes something like this. Surely someone will correct me if I’m wrong.

Generally dividends are taxed as ordinary income, while capital gains are not. So tax-wise (at least at the margin), a dollar of dividend income is not worth as much as a dollar of capital gains income, after tax.

Not quite true. Qualified dividends are taxed the same as long-term capital gains. Non-qualified dividends and short-term capital gains are both taxed as regular income.

[Toons]

My spouse and I are retired
I quit fretting about taxes in taxable account years ago.
I have several balanced funds,managed equity funds and individual stocks in my taxable account.
I now take all the dividends and capgains in cash.I had reinvested for years,
I pay taxes ,although ,in retirement it is a lot less than it was when we were working.
Everybody's situation is different.The above works fine for us.

[SGM]

Qualified dividends are not taxed the same as ordinary income. However, LT capital gains taxes are more efficient as the total amount you withdraw is not taxed. The new tax law has decreased the taxes on pass through income such as REIT dividends. There is a 20% discount which I discussed on another post.

I no longer reinvest dividends or capital gains since I retired. To live off of dividends alone you either need to have a large portfolio or have additional sources of income or you have very low expenses.

I look at total return, but I am stuck with dividends so I generally spend what I get before I sell positions.

[zekevfab]

I am interested by this subject as well. As stated in some answers above, the dividend yield is less volatile than the stock prices. And now especially if you select the stocks yourself based on their dividend history (some companies like XOM have been paying dividends for decades).

I would be interested by high dividend stocks as a higher yield alternative to supplement bonds to provide some diversification and resiliency in case of prolonged recession.

A dividend income fund does not protect you from an economic recession. Vanguard Equity Income Fund behaved in the same way as Total Stock Market Index during the last recession.

Yes you are right, but it continues to provide a revenue stream that low dividend stocks do not provide, even if the value of the stock falls. At least it has in past recessions.

[dbr]

Thanks in advance to all for taking time to read and share your thoughts and opinions.

I can save you waiting for replies to come in by referring you to the results of this search:

https://www.google.com/search?sitesearc ... =dividends

[Tyler Aspect]

A dividend income fund does not protect you from an economic recession. Vanguard Equity Income Fund behaved in the same way as Total Stock Market Index during the last recession.

Yes you are right, but it continues to provide a revenue stream that low dividend stocks do not provide, even if the value of the stock falls. At least it has in past recessions.

When you take the dividends out of the fund, its net asset value drops by the same amount. This is not free money that comes out of thin air.

[pkcrafter]

Welcome,

However, what is the forums opinion regarding investing a lump sum (windfall) in VHYDX during retirement, in a taxable account, if the dividends are equal to the amount one wishes to withdraw annually? Could this possibly be a good position in the event of a market downturn, which might make selling off shares of say Vanguard Total Stock Market Index Fund VTSMX (to receive the same amount of income) unattractive?

The biggest problem I see with the dividend strategy is a withdrawal is a withdrawal: therefore, at times you will be withdrawing from equity when the market is down, which isn't a good idea. When the market is down you should be rebalancing into equities, not withdrawing.

Paul

[naha66]

Welcome,

However, what is the forums opinion regarding investing a lump sum (windfall) in VHYDX during retirement, in a taxable account, if the dividends are equal to the amount one wishes to withdraw annually? Could this possibly be a good position in the event of a market downturn, which might make selling off shares of say Vanguard Total Stock Market Index Fund VTSMX (to receive the same amount of income) unattractive?

The biggest problem I see with the dividend strategy is a withdrawal is a withdrawal: therefore, at times you will be withdrawing from equity when the market is down, which isn't a good idea. When the market is down you should be rebalancing into equities, not withdrawing.

Paul

And withdrawal from a total return when the market is down is not selling during a market downturn.

Well he's in the withdrawal phase so hopefully he has a mix of equity and bond funds. Their is always a chance you need to withdrawal from equity funds when the market is down.

[dbr]

Welcome,

However, what is the forums opinion regarding investing a lump sum (windfall) in VHYDX during retirement, in a taxable account, if the dividends are equal to the amount one wishes to withdraw annually? Could this possibly be a good position in the event of a market downturn, which might make selling off shares of say Vanguard Total Stock Market Index Fund VTSMX (to receive the same amount of income) unattractive?

The biggest problem I see with the dividend strategy is a withdrawal is a withdrawal: therefore, at times you will be withdrawing from equity when the market is down, which isn't a good idea. When the market is down you should be rebalancing into equities, not withdrawing.

Paul

And withdrawal from a total return when the market is down is not selling during a market downturn.

Well he's in the withdrawal phase so hopefully he has a mix of equity and bond funds. Their is always a chance you need to withdrawal from equity funds when the market is down.

That is correct. Nothing can save you from that except not spending when returns are tiny or negative. But so what, that is how this works. Someone who thinks you can fund a retirement from a volatile portfolio and never withdraw when assets are down fundamentally does not understand the idea. If a person wants to avoid this by holding only assets that don't go down in real dollars, then that can be done but such a person has to compare the consequences of holding low returning assets instead of higher returning assets to do that. Another alternative is to buy an annuity and figure out how to deal with inflation if it isn't an inflation indexed annuity. In addition once highly reliable income streams are established, as with an annuity, the person has to understand how to deal with needs that may arise unanticipated. The whole thing is really simple enough but it is not helpful to try to make it more simple than it really is. However, none of this has anything whatsoever to do with dividends.

[Da5id]

If you were in retirement, had a lump sum to invest in a taxable account (in the US portion of a three fund portfolio) and would only need income equal to the amount of dividends that VHYDX happens to provide, would you invest in VHYDX, invest in VTSMX, invest in both or do something different?

I'd pick Total Stock Market myself. The VTSAX rather than VTSMX if enough money is involved, if it is less than $10K the difference in taxes is not all that bit a deal anyway in the context of money needed for retirement.

Avoid the "dividends are stable free magical manna from heaven" thinking. Invest for total return.

That said, if you decide that you want VHYDX for whatever reason, having it in taxable if you are going to spend all the dividends anyway is a fine choice. There is no extra tax drag in this particular case.

[dbr]

If you were in retirement, had a lump sum to invest in a taxable account (in the US portion of a three fund portfolio) and would only need income equal to the amount of dividends that VHYDX happens to provide, would you invest in VHYDX, invest in VTSMX, invest in both or do something different?

I prefer to withdraw and spend what I need rather than thinking my cash flow management can only be manipulated by standing ten miles away configuring dividend payouts, so the amount of dividends plays no role.

As to the choices of funds I would just select the diversified market cap fund and not worry about concentrating in any particular asset class.

[livesoft]

One couldn't buy VHYDX because it does not exist.

What are the yields of VHDYX and VTSAX? What percentages of their dividends are qualified dividends?

Actually, it doesn't matter. If one uses morningstar.com and compares the past performance of the two funds, then one would not have any argument at all to buy any VHDYX. They would buy VTSAX.

[MotoTrojan]

Less diverse, potentially higher taxes, no additional safety. Dividends aren’t free/magic money.

[bertilak]

Whatever taxes are owed, are owed when the dividends are generated not when they are spent or withdrawn from the portfolio. Any reasonably diversified portfolio is going to spit out dividends.

If you need the money for expenses you should spend those dividends. Reinvesting and then selling (in the quest for "total return") will simply generate additional taxable events as well as more complicated paperwork. In other words, you cannot save on taxes by selling stocks/funds and spending the proceeds instead of spending the dividends. You get those dividends and the associated tax consequences whether you are looking at "total return" or not. Remember, dividends are a big part of "total return." Besides, who can better manage the disposition of company profits -- you or the insiders managing the company?

Whether or not one should deliberately chase after high-dividend stocks is a different issue. I believe there is some justification for that. The fact that dividends also go down during a market downturn is a straw-man argument. Sure they do, but not nearly as much nor as fast as prices. Dividends act to stabilize total return -- a good thing. To the extent one can live off of dividends, one can avoid selling in a down market -- another way of saying he same thing. I say "some" justification because chasing after any class of assets puts a drag on diversification. It's a trade-off probably not worth fretting over.

(P.S. Some people go for high-dividend stocks for other reasons, for example as an indicator of a strong company or of more reliable reporting.)

[Lynette]

Your situation may vary but for me in retirement, dividends are a real nuisance as they add to my MAGI that is used to determine Medicare IRMAA payments. I have pensions, SS and have to take RMDs. I am not using my taxable account at this stage so anything that adds to my MAGI is a problem. In addition I think that some try to get ACA subsidies if they retire early. As far I am aware, dividends also add to MAGI that determines ACA subsidies. For Medicare, if one goes one dollar over the limit, you are into the next bracket for paying premiums.

[Darth Xanadu]

This forum taught me to focus on total return, within the framework of personal asset allocation. I'm fortunate that I didn't venture too far down the dividend strategy before realizing (thanks to folks here) that I can achieve my goals more efficiently with less headache, hassle, and worry.

[Nate79]

People often get confused when talking about dividends for mutual funds vs individual companies. The concepts between the two are very similar but it is easier to think about for mutual funds.
For a mutual fund dividends accrue over time as the underlying companies pay their dividends to the mutual fund company. These dividends accrue and are reflected in the daily NAV value. The underlying companies are paying dividends on all sorts of schedules and these dividends build and build in the NAV. What this means is that part of the price of the mutual fund is actually made up of the underlying dividends being held my the mutual fund company.

Now, two situations. One the mutual fund is one you purchased directly by law the mutual fund must distribute the dividends on some schedule they determine. When the dividend is paid that cash distribution comes directly out of the NAV for the fund. Your total value did not change.

Second situation is you may own a fund in a 401k that might be a trust (CIT). These funds are not required by law to distribute the dividends and instead just keep accruing.

If the funds are the same (same expense, etc) then you will be in the same exact situation whether the fund pays out the dividend or it accrues.

If instead you decide to sell some of the shares of the CIT fund in your 401k to match the dividend distribution then you are in the same exact total value situation. The only difference is that by distributing a dividend in a taxable account causes by law a taxable event.

If the fund distributes a dividend when the market is down or if you sell shares to generate that same amount of cash is exactly the same in terms of total value in your account. Number of shares and share price for a mutual fund is a completely arbitrary numbers and in fact you don't even need to think about these values. All you need to think about is the total value of your holding of a mutual fund. If you sell shares or the mutual fund distributes some of it's NAV value it is the exact same in terms of value in your account.

This is the whole point of why to think about total return vs just focusing on dividends.

[dbr]

People often get confused when talking about dividends for mutual funds vs individual companies. The concepts between the two are very similar but it is easier to think about for mutual funds.
For a mutual fund dividends accrue over time as the underlying companies pay their dividends to the mutual fund company. These dividends accrue and are reflected in the daily NAV value. The underlying companies are paying dividends on all sorts of schedules and these dividends build and build in the NAV. What this means is that part of the price of the mutual fund is actually made up of the underlying dividends being held my the mutual fund company.

Now, two situations. One the mutual fund is one you purchased directly by law the mutual fund must distribute the dividends on some schedule they determine. When the dividend is paid that cash distribution comes directly out of the NAV for the fund. Your total value did not change.

Second situation is you may own a fund in a 401k that might be a trust (CIT). These funds are not required by law to distribute the dividends and instead just keep accruing.

If the funds are the same (same expense, etc) then you will be in the same exact situation whether the fund pays out the dividend or it accrues.

If instead you decide to sell some of the shares of the CIT fund in your 401k to match the dividend distribution then you are in the same exact total value situation. The only difference is that by distributing a dividend in a taxable account causes by law a taxable event.

If the fund distributes a dividend when the market is down or if you sell shares to generate that same amount of cash is exactly the same in terms of total value in your account. Number of shares and share price for a mutual fund is a completely arbitrary numbers and in fact you don't even need to think about these values. All you need to think about is the total value of your holding of a mutual fund. If you sell shares or the mutual fund distributes some of it's NAV value it is the exact same in terms of value in your account.

This is the whole point of why to think about total return vs just focusing on dividends.

Correct. In short you can do correct accounting or you can ignore fourth grade arithmetic and wander around in la-la land.

[keepingitsimple]

Many thanks to all for contributing to this conversation. I now understand and agree with the logic behind investing for total return vs. investing for dividends. Though dividends can be enticing, I can see they are rather misleading. I'm most appreciative for your continued input and look forward to reading more.

[bltn]

People often get confused when talking about dividends for mutual funds vs individual companies. The concepts between the two are very similar but it is easier to think about for mutual funds.
For a mutual fund dividends accrue over time as the underlying companies pay their dividends to the mutual fund company. These dividends accrue and are reflected in the daily NAV value. The underlying companies are paying dividends on all sorts of schedules and these dividends build and build in the NAV. What this means is that part of the price of the mutual fund is actually made up of the underlying dividends being held my the mutual fund company.

Now, two situations. One the mutual fund is one you purchased directly by law the mutual fund must distribute the dividends on some schedule they determine. When the dividend is paid that cash distribution comes directly out of the NAV for the fund. Your total value did not change.

Second situation is you may own a fund in a 401k that might be a trust (CIT). These funds are not required by law to distribute the dividends and instead just keep accruing.

If the funds are the same (same expense, etc) then you will be in the same exact situation whether the fund pays out the dividend or it accrues.

If instead you decide to sell some of the shares of the CIT fund in your 401k to match the dividend distribution then you are in the same exact total value situation. The only difference is that by distributing a dividend in a taxable account causes by law a taxable event.

If the fund distributes a dividend when the market is down or if you sell shares to generate that same amount of cash is exactly the same in terms of total value in your account. Number of shares and share price for a mutual fund is a completely arbitrary numbers and in fact you don't even need to think about these values. All you need to think about is the total value of your holding of a mutual fund. If you sell shares or the mutual fund distributes some of it's NAV value it is the exact same in terms of value in your account.

This is the whole point of why to think about total return vs just focusing on dividends.

Very nice explanation.
While many believe that indexing the market is the most efficient method for investing, there have been studies that demonstrate that dividend paying stocks, as a group, out perform the overall market, which includes non dividend paying stocks.