Dividend Fund Slice or Stick To Total Stock Market

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ulladulla28
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Dividend Fund Slice or Stick To Total Stock Market

Post by ulladulla28 » Tue May 09, 2017 10:32 am

Bogleheads,

I posted this in an older thread, but thought I would start a new one to see if generates any discussion... I am a good 15-20 years from early retirement, and keep it simple with total stock market/ Intermediate Bond, but do have to slice and dice with some mid cap and small cap index funds, as my 401k only offers an acceptable ER on an S&P 500 index. Either way, I have been contemplating adding a dividend generating fund somewhere in the mix.....

I have been reading a bit on this subject and decided to test it out on portfolio visualizer website because it can show portfolios, backing out the dividend reinvestment.

Here is the link, but summary below.
https://www.portfoliovisualizer.com/bac ... tion3_3=25

I HOPE THE LINK WORKS!!!!


I back tested three portfolios without reinvesting dividends. Each portfolio has a 50% allocation to the vanguard intermediate bond fund and the equity postion is either all total stock market, all equity income fund, or an even split of the two.

Portfolio 1 - 50% Vanguard Intermediate Bond Fund - 50% Vanguard Total Stock Market
Portfolio 2 - 50% Vanguard Intermediate Bond Fund - 50% Vanguard Equity Income
Portfolio 3 - 50% Vanguard Intermediate Bond Fund - 25% Vanguard Total Stock Market - 25% Vanguard Equity Income

The portfolio (1) with only total stock market and bond market, certainly appreciates the most in value, but adding a dividend fund component to your equity position (portfolio 3) certainly generates more income and also seems to reduce risk/volatility. (See 2002 and 2008 draw downs) Additionally, if you had truly been selling shares from portfolio 1 to make up the income gap between it and portfolio 3 (or even portfolio 2), I suspect that the final value of portfolio 1 may be a good bit closer to that of portfolio 3 or perhaps even less.

As I said, a long way from retirement, but I have been thinking of placing some sort of dividend fund in my portfolio. Probably in the taxable account (I know I know) because it is what I would need to tap for an early retirement.

Just looking for some thoughts and insight on this.

Thanks!

FinancialDave
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by FinancialDave » Tue May 09, 2017 11:33 am

I don't see a purpose in putting a dividend fund in your taxable account, as this is just going to create a bigger taxable event for you along the way and a smaller retirement.

If you want to build a taxable account you need a tax efficient fund, in your case the VTSAX. Once you get to retirement you can sell down some of the shares to live off.

Also, what is the purpose of not reinvesting the dividends? You want to compound these funds as well.

Dave
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rkhusky
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by rkhusky » Tue May 09, 2017 11:37 am

You pay capital gain rates when selling shares of your fund in taxable, which is currently the same rate that you would pay on qualified dividends, but less than the tax rate you would pay for non-qualified dividends. And since dividends in a stock fund cause the NAV to drop proportionally, there doesn't appear to be any reason to prefer dividends over capital gains.

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David Jay
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by David Jay » Tue May 09, 2017 12:08 pm

Dividend focused investing is a mirage that plays on some of our (human) behavioral preferences. Especially with decades before retirement, you need to focus on total return, not on dividends.

Here is a good thread on the subject: viewtopic.php?t=212002 (You should read the Larry Swedroe article - link on that thread)
Prediction is very difficult, especially about the future - Niels Bohr | To get the "risk premium", you really do have to take the risk - nisiprius

ulladulla28
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by ulladulla28 » Tue May 09, 2017 3:57 pm

FinancialDave wrote:I don't see a purpose in putting a dividend fund in your taxable account, as this is just going to create a bigger taxable event for you along the way and a smaller retirement.
Agreed, the tax paid on dividends until retirement would erode the final value by 15%.
FinancialDave wrote:If you want to build a taxable account you need a tax efficient fund, in your case the VTSAX. Once you get to retirement you can sell down some of the shares to live off.
I thought the Boglehead philosophy was to buy and hold forever? Also, when selling shares, you miss out on the future appreciation of those shares.
FinancialDave wrote:Also, what is the purpose of not reinvesting the dividends? You want to compound these funds as well
I do. I should have been more clear, but the point of the illustration was to depict retirement (not pre-retirement) so the retiree would just be collecting income from the account without having to sell anything.
rkhusky wrote:You pay capital gain rates when selling shares of your fund in taxable, which is currently the same rate that you would pay on qualified dividends, but less than the tax rate you would pay for non-qualified dividends. And since dividends in a stock fund cause the NAV to drop proportionally, there doesn't appear to be any reason to prefer dividends over capital gains.
Dividend focused investing is a mirage that plays on some of our (human) behavioral preferences. Especially with decades before retirement, you need to focus on total return, not on dividends.

Great points here, but it still seems to me that relying on an investor to select which shares of which fund to sell at what point in time, actually creates too much opportunity for human/behavioral error.

My only reason for even thinking about all of this is to generate a decent enough revenue stream from a taxable account to fund an early retirement.

FinancialDave
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by FinancialDave » Tue May 09, 2017 8:28 pm

ulladulla28 wrote:
My only reason for even thinking about all of this is to generate a decent enough revenue stream from a taxable account to fund an early retirement.
FinancialDave wrote:If you want to build a taxable account you need a tax efficient fund, in your case the VTSAX. Once you get to retirement you can sell down some of the shares to live off.
I thought the Boglehead philosophy was to buy and hold forever? Also, when selling shares, you miss out on the future appreciation of those shares.
As others have alluded to many times on this site, dividends are no magic elixir, so whether you sell some shares or just use the dividends the result is very similar.


The size of the revenue stream that can be generated is a function of the total return you generate betweeen now and retirement. It really has nothing to do with the internal dividends generated along the way, or even in retirement for that matter.

Income in retirement, early or otherwise, can be generated by a number of different methods, but the amount of income you can generate in retirement still will be contingent on the strategy you pick.

It sounds like you think you can save enough in your taxable account to just live off the dividends and retire early. That's fine if you can because that would probably put you in the top 1-5%, but I would focus on getting there first.
I love simulated data. It turns the impossible into the possible!

avalpert
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by avalpert » Tue May 09, 2017 10:57 pm

ulladulla28 wrote:[

I thought the Boglehead philosophy was to buy and hold forever? Also, when selling shares, you miss out on the future appreciation of those shares.
If that was really the Boglehead philosophy it would be completely unappealing to almost anyone - what is the point in holding a stock fund forever, its not like they are going to bury you with them.

The purpose of investing is to have means for future consumption - everyone (whether this generation or in a future one) intends to trade their investments for goods and services at some point and give up on future appreciation in exchange for current utility.

AlohaJoe
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by AlohaJoe » Tue May 09, 2017 11:22 pm

ulladulla28 wrote:
Additionally, if you had truly been selling shares from portfolio 1 to make up the income gap between it and portfolio 3 (or even portfolio 2), I suspect that the final value of portfolio 1 may be a good bit closer to that of portfolio 3 or perhaps even less.
You don't need to guess. PortfolioVisualiser lets you add in withdrawals. If you withdraw $120,000 a year (4% of the initial portfolio) then -- after 15 years -- the portfolios are nearly identical.

While the TSM doesn't "win"...it also doesn't look like there is really anything to recommend the income approach. The drawdowns are the same (-31%). They are so similar that slight changes to start or end points changes the result -- start in 2003 instead of 2002 and the TSM comes out (slightly) ahead. A stable strategy should have similar results even if you change the start or end point by a few months.

In both cases you have more than enough income and more than enough money for the rest of your life....the amount that you withdraw in retirement matters a thousand times more than whatever asset allocation you use.

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House Blend
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by House Blend » Wed May 10, 2017 9:22 am

ulladulla28 wrote:Great points here, but it still seems to me that relying on an investor to select which shares of which fund to sell at what point in time, actually creates too much opportunity for human/behavioral error.

My only reason for even thinking about all of this is to generate a decent enough revenue stream from a taxable account to fund an early retirement.
Treating dividends as the precise amount that one can safely spend, or limiting yourself to spending dividends only, is a more serious behavioral error. It leads to unnecessary deprivation or working longer than necessary.

Here are some additional decisions you may have to make; don't forget to worry about behavioral mistakes with these too:

* when to rebalance? which shares to sell when doing so?
* when to take RMDs? which funds to take them from?
* should you do Roth conversions? when? how much? which funds?

If you prefer to automate as much of it as possible, fine, but limiting yourself to dividends only is a very costly form of automation.

ulladulla28
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by ulladulla28 » Wed May 10, 2017 9:52 am

Thanks to all for the feedback here. I think I can agree that there really is not much difference if you start with equal amounts at retirement, but it does seem to me that the tax paid on dividends on the way to retirement can hamper the starting amount at retirement if you are in the dividend fund in lieu of the tsm...
avalpert wrote:You don't need to guess. PortfolioVisualiser lets you add in withdrawals. If you withdraw $120,000 a year (4% of the initial portfolio) then -- after 15 years -- the portfolios are nearly identical.
Thanks! I just saw this and it is very helpful.

dcarste
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Re: Dividend Fund Slice or Stick To Total Stock Market

Post by dcarste » Wed May 10, 2017 10:06 am

Favorite quote - I had to convince my dad not to go for dividend stocks only. I actually treat the S&P 500 "in my head" as one company that pays a yield. That is the company I own, the American Economy. Easier to see if I am willing to just dollar cost average like normal and buy some more S&P500 shares if they drop 30%.

"More Money Has Been Lost Reaching For Yield Than At The Point Of A Gun"

that goes for both stocks and bonds.

At any other point I can remember that point rings true now, as many have decided over the past 5 years to invest in higher yielding stocks driving them WAY above their historical PE.

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