Invest for income?

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sillysaver
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Invest for income?

Post by sillysaver » Thu Sep 06, 2018 6:48 am

I came across a newsletter that touts an "8% withdrawal-free retirement portfolio," citing the sequence of return risk in a "normal" portfolio with a 4% safe withdrawal rate. This service recommends all kinds of high-paying dividend investments like closed-end-funds that trade at discounts to NAV and pay above-average dividend yields.

A lot of people are searching for yield, and I see the appeal of regular dividends. I have owned dividend stocks in the past, too. At one point, however, I got away from individual stocks. I moved to a portfolio broad market-weighted index funds, figuring that exposure to the entire universe of investments (including growth, or non-dividend paying) was the best way to go for someone with a lot of time ahead of him. Since I'm not retired, I could go with a (theoretically) faster growing portfolio and forego income, in exchange for some volatility. Although now, with expected returns so low, I'm wondering if income oriented investments might not outperform the broad market?

The skeptic (ie. boglehead) in me sees a couple issues with buying high-yielding CEF's:

- If the yield is above average, these funds must be taking on some extra risk. In the case of CEF's, many of them use leverage. Also, the share prices appear to be more sensitive to interest rate fluctuations.
- Some funds may be simply returning shareholders' original capital

In addition, the market's myopic focus on dividends as a proxy for value has resulted in anomalies like dividend-paying investments that are overvalued relative to the broad market, VIG being a good example.

On the other hand, if you could find the "right" funds, maybe you could avoid these problems. I see the appeal, so I ponied up for the trial subscription and started reading about some of the recommendations. Is there anything wrong with investing this way for someone my age (41)? I don't have quite enough to live off the income, but I see the appeal of a stable income stream that is less "exposed" to market downside (esp. when the market appears to be so overvalued). What's the right way to think about this?

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Phineas J. Whoopee
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Re: Invest for income?

Post by Phineas J. Whoopee » Thu Sep 06, 2018 7:29 am

Furthermore, taking dividends out of a portfolio is a withdrawal.
PJW

simas
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Re: Invest for income?

Post by simas » Thu Sep 06, 2018 8:18 am

The right way to think about it is ignore it . this is discussed here at regular intervals
- a dollar (from your portfolio) is a dollar is a dollar. for spending purposes it does not matter to you whether the original source was 'income' ,'dividend', 'capital gain' , 'capital loss', or none of the above, it is still a dollar
- Vanguard published a good paper discussing investing for income and concluding it is not the most optimal approach. instead investor should be thinking of total portfolio return (be it dividend income or capital appreciation), this is what matters.
- tax wise, it various greatly on your locale (country , state, etc), other income ,etc. hard to generalize.

Topic Author
sillysaver
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Re: Invest for income?

Post by sillysaver » Thu Sep 06, 2018 8:30 am

What about the rates of return? Is a 7-8% yield not better than the market's expected return of about 4% nominal?

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Sandtrap
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Re: Invest for income?

Post by Sandtrap » Thu Sep 06, 2018 9:27 am

sillysaver wrote:
Thu Sep 06, 2018 8:30 am
What about the rates of return? Is a 7-8% yield not better than the market's expected return of about 4% nominal?
. . . I came across a newsletter that touts an "8% withdrawal-free retirement portfolio," . . .
Can you provide a link or reprint of this newsletter?
Wiki Bogleheads Wiki: Everything You Need to Know

Topic Author
sillysaver
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Re: Invest for income?

Post by sillysaver » Thu Sep 06, 2018 9:47 am

See: https://contrarianoutlook.com/

Excerpt:

The Secure 8% “No Withdrawal” Portfolio

by Brett Owens, Chief Investment Strategist

Just say “no thanks” to the 4% fallacy – and hello to a sleep-well 8%.

We’ve got a “no withdrawal” portfolio that doubles up the income you’d generate from selling 4% of your stocks annually. And it’s much easier on your blood pressure, because it preserves 100% of your capital to boot.

Financial advisors love to dish their 4% “sell-as-you-go strategy” to retirees. These guys (who have not successfully retired yet themselves, by the way) say that you should supplement your dividend income by withdrawing 4% or so annually from your capital basis.

It sounds good on paper, but it’s disastrous in practice. Just do the math.

The fatal flaw with the 4% annual withdrawal strategy starts with a chart that looks like this:

(chart of MSFT during a 56.6% drawdown in 2008)

In the Short Run, Stock Prices are Random

This dividend is fine (it’s actually rising), but you need to sell shares for additional income. Problem is, you want to buy low and sell high … but this strategy would have you do the exact opposite, withdrawing your money at precisely the wrong time.

Remember the benefits of dollar cost averaging that built your retirement portfolio? This is the same phenomenon, but in reverse!

With the 4% withdrawal portfolio, you sell more shares of stock when prices are low, and less when prices are high. That’s not a recipe for retiring comfortably – that’s a recipe for running out of money.

If you’re worried about a stock market pullback or crash – and I don’t blame you with equities near record-high valuations – then we need to transition your portfolio away from the casino of stock prices into the steady staircase of dividends.

That’s where my 8% “No Withdrawal” portfolio comes in.

------

So from what I can tell so far the strategy is based on:

- Buying high-yielding income CEF's at a discount to NAV
- Assuming appreciation as the discount closes
- Owning CEF's that invest in dividend-paying equities and income securities like preferred's, high-yield bonds, etc.
- Buying REIT's when the yields are above historical averages
etc

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Phineas J. Whoopee
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Re: Invest for income?

Post by Phineas J. Whoopee » Thu Sep 06, 2018 9:58 am

Taking dividends out of a portfolio is a withdrawal. The newsletter writer knows that.
PJW

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Sandtrap
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Re: Invest for income?

Post by Sandtrap » Thu Sep 06, 2018 10:01 am

Thanks for posting the link.
Interesting website.
However this excerpt from the website caused me to read no further:
How to Retire on $300,000 (and bag 12% gains every year)
Michael Foster, Investment Strategist
Updated: September 3, 2018
Today I’m going to show you how to get a livable income stream from a $300,000 nest egg—while growing your savings at the same time.

Sounds impossible, right?

Wrong.
Something about . . . "If it sounds too good to be true . . . . " :shock:

Perhaps a better place to pursue investing for income:
Bogle Philosophy
https://www.bogleheads.org/wiki/Bogleh ... hilosophy
Here are links to the wiki's "Getting Started" and "Investing Startup Kit" pages:
https://www.bogleheads.org/wiki/Getting_started
https://www.bogleheads.org/wiki/Bogleh ... rt-up_kit
etc.
j
Wiki Bogleheads Wiki: Everything You Need to Know

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unclescrooge
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Re: Invest for income?

Post by unclescrooge » Thu Sep 06, 2018 10:04 am

sillysaver wrote:
Thu Sep 06, 2018 9:47 am
So from what I can tell so far the strategy is based on:

- Buying high-yielding income CEF's at a discount to NAV
- Assuming appreciation as the discount closes
- Owning CEF's that invest in dividend-paying equities and income securities like preferred's, high-yield bonds, etc.
- Buying REIT's when the yields are above historical averages
etc
I use this strategy to buy Muni funds. In one of my funds (mzf), the shareholders just voted to liquidate the fund and thus profit from the discount 😀

The leverage often comes in the form of preferred shares, so there is less interest rate sensitivity, although the funds can be very volatile. You can use morningstar's z-score to look at the average discount over the past few years and buy when the discount widens.

Historically, equity funds that trade at a discount to NAV never close the gap in the discount. This is less profitable than bonds.

Trading based on historical yields rarely works in practice. Going off memory, REITs yielded 8% historically, so you would be out of the market for many years.

That being said, I think investing solely for income is as mistake. CEF funds usually have very high expense ratios.

Take the subscription as a learning tool, but there is no holy Grail.

Topic Author
sillysaver
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Re: Invest for income?

Post by sillysaver » Thu Sep 06, 2018 10:05 am

I know this has been discussed ad nauseum, but aren't dividends somehow more "reliable" than share price appreciation?

Also, if you're getting 7-8% dividends consistently, your sequence of return risk would seem to be lower than if you're getting 4% real and withdrawing 4% per year. Because in the second portfolio, you might be up 20% in one year or down 56% the next.

Sorry if I am being dense, but I find the idea very alluring. Please prove it wrong. :)

Topic Author
sillysaver
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Re: Invest for income?

Post by sillysaver » Thu Sep 06, 2018 10:06 am

unclescrooge wrote:
Thu Sep 06, 2018 10:04 am
Take the subscription as a learning tool, but there is no holy Grail.
Thanks for your input, unclescrooge, that was my intention.

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unclescrooge
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Re: Invest for income?

Post by unclescrooge » Thu Sep 06, 2018 10:12 am

sillysaver wrote:
Thu Sep 06, 2018 10:05 am
I know this has been discussed ad nauseum, but aren't dividends somehow more "reliable" than share price appreciation?

Also, if you're getting 7-8% dividends consistently, your sequence of return risk would seem to be lower than if you're getting 4% real and withdrawing 4% per year. Because in the second portfolio, you might be up 20% in one year or down 56% the next.

Sorry if I am being dense, but I find the idea very alluring. Please prove it wrong. :)
Anything offering an 8% yield in a 2% environment is much more risky.

If you want 8% then just use 10% if your portfolio to buy Argentina bonds... They're currently yelling yielding 60%.....mainly because the risk of default is so high.

magicrat
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Re: Invest for income?

Post by magicrat » Thu Sep 06, 2018 10:12 am

sillysaver wrote:
Thu Sep 06, 2018 9:47 am

Financial advisors love to dish their 4% “sell-as-you-go strategy” to retirees. These guys (who have not successfully retired yet themselves, by the way) say that you should supplement your dividend income by withdrawing 4% or so annually from your capital basis.

This is not what the 4% rule is. This is more like the ~6% rule, which of course will be much more likely to fail.

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Phineas J. Whoopee
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Re: Invest for income?

Post by Phineas J. Whoopee » Thu Sep 06, 2018 10:17 am

sillysaver wrote:
Thu Sep 06, 2018 10:05 am
I know this has been discussed ad nauseum, but aren't dividends somehow more "reliable" than share price appreciation?
Share prices fluctuate both up and down. The sum, over some periods negative, of share price fluctuations and distributions are total return, which is what's important. Total return over any period of time easily could be negative, whether you withdraw dividends from your portfolio or not.
sillysaver wrote:
Thu Sep 06, 2018 10:05 am
Also, if you're getting 7-8% dividends consistently, your sequence of return risk would seem to be lower than if you're getting 4% real and withdrawing 4% per year. Because in the second portfolio, you might be up 20% in one year or down 56% the next.
Stock dividends come directly out of share prices.
sillysaver wrote:
Thu Sep 06, 2018 10:05 am
Sorry if I am being dense, but I find the idea very alluring. Please prove it wrong. :)
The burden of proof rests with the person making the affirmative claim, who in this case is the equivocating newsletter writer.

PJW

treypar
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Re: Invest for income?

Post by treypar » Thu Sep 06, 2018 10:23 am

I have been withdrawing my dividends and interest for income in retirement. It has worked so far.

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Phineas J. Whoopee
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Re: Invest for income?

Post by Phineas J. Whoopee » Thu Sep 06, 2018 10:32 am

treypar wrote:
Thu Sep 06, 2018 10:23 am
I have been withdrawing my dividends and interest for income in retirement. It has worked so far.
Nobody claims dividends and interest can't meet expenses if the portfolio is big enough.

PJW

simas
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Re: Invest for income?

Post by simas » Thu Sep 06, 2018 7:40 pm

sillysaver wrote:
Thu Sep 06, 2018 10:05 am
Sorry if I am being dense, but I find the idea very alluring.
this is probably the most troubling... the general advice here is DYI. However , if your 'lizard brain' responds to such allures, low cost advisor who will keep you on course (by not allowing us to scew yourself over), may be of value to you...

in short, you already had all the answers you need
- this newsletter content is BS , setting up false comparisons (4% vs 8%). strategy similarly 'entertainment value only'.
- if newsletter truely knows of such amazing successful strategy (known working arbitrage opportunity), the last thing it would do is publish it.. however, only for you ,and only today, and only for 3 easy payments, if you order in the next 10 minutes, plus!! a free gift (cue informercial on). *yawn* . I am sure you heard of same pitch on other "amazing opportunities" (flip houses and make millions! no one went broke by owning land! blah-blah-blah).
- if you want to succeed in investing, stay away from these
- if you want 'entertainment', get Netflix , much cheaper , easy, and more fun.

Topic Author
sillysaver
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Re: Invest for income?

Post by sillysaver » Thu Sep 06, 2018 8:38 pm

simas wrote:
Thu Sep 06, 2018 7:40 pm
sillysaver wrote:
Thu Sep 06, 2018 10:05 am
Sorry if I am being dense, but I find the idea very alluring.
this is probably the most troubling... the general advice here is DYI. However , if your 'lizard brain' responds to such allures, low cost advisor who will keep you on course (by not allowing us to scew yourself over), may be of value to you...
I am pretty disciplined these days after having been burned on some investments (many coming from newsletters) before. Inertia and skepticism keep me from doing stupid things. But every once in a while I think "what if?"

venkman
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Re: Invest for income?

Post by venkman » Thu Sep 06, 2018 11:00 pm

sillysaver wrote:
Thu Sep 06, 2018 10:05 am
Also, if you're getting 7-8% dividends consistently, your sequence of return risk would seem to be lower than if you're getting 4% real and withdrawing 4% per year. Because in the second portfolio, you might be up 20% in one year or down 56% the next.

Sorry if I am being dense, but I find the idea very alluring. Please prove it wrong. :)
I can't prove it wrong, but I can offer a pretty good rule of thumb:

When in doubt, assume markets are efficient.

If the market thought this was a good deal, everyone would pile in until it wasn't a good deal anymore. The fact that the market HASN'T piled in suggests that maybe it's not as good a deal as it seems to be.

More precisely: this deal, on a risk/reward basis, is about equal to every other deal, based on the market's collective guess about the future.

ChinchillaWhiplash
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Re: Invest for income?

Post by ChinchillaWhiplash » Thu Sep 06, 2018 11:17 pm

There are some CEFs which have performed quite well over the last several decades. There are some that have performed better than the oldest Vanguard S&P 500 index fund. Same can be said for bond index fund. They only perform better due to dividend reinvestment. Some have even done so without the use of leverage. Leverage is a big advantage of CEFs. They are able to use leverage to boost a dividend up. I personally hold some as part of my bond allocation. They are riskier than total bond index and can drop more, but it worth holding some IMHO. A lot of research needs to go into choosing them though and you do need to be aware of the risks. Even with a much higher ER, total returns can exceed index funds over an extended period. I used Portfolio Visualizer backtesting of some funds that date back to 1988-89 to help me decide what to purchase. There is a history of high enough returns in the form of high yield to make it worthwhile, especially in the high yield bond sector to used an actively managed CEF. These are used in conjunction to TBM index fund. I could be wrong, but there is a long track record supporting my choices to get higher returns and still minimize risk. MFS has a lot of bond CEFs that are appealing. This company has been around since 1924. I still use low cost index funds for the majority of holdings, but can see a benifit to holding a few actively managed funds in places like EM and HY corporate bonds. I like the fact that you can get CEFs at a large discount to NAV and that there is the potential for leveraging strategies to maintain a high yield at all times. I have over a 10 year time frame to let these run and grow with drip. Would not use them anywhere other than a tax deferred account either.

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sillysaver
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Re: Invest for income?

Post by sillysaver » Fri Sep 07, 2018 7:13 am

A little over 10 years ago, I remember buying a closed end junk bond fund (DSU - Debt Strategies Fund) as part of my fixed income allocation. It was an Oxford Club recommendation. It collapsed to some ridiculous fraction of its former peak in 2008, during the financial crisis. When I look at the chart, I see it dropped from $23 to $6, but it did recover some and is trading at just over $11. Now, if you had reinvested the dividends, it might not have been so bad, but the distribution was cut as well by over half.

This is not a problem with closed end funds per se, but I guess the lesson is understand what the underlying assets are and what the risks are. Also, I've since read advice from people like Larry Swedroe who advocate only holding US government bonds for the fixed income allocation.

Even though I said I find the idea of high-yielding CEF's interesting, I still remember the pain from this episode. It's enough to keep me from pulling the trigger on another "high-yielding" investment unless I truly understand how it works. Which is why I posted my original question.

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