Dividends vs. Capital Gains for Spending Needs?

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avalpert
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Fri Oct 06, 2017 8:19 pm

nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here?
No, we can't. I'll give him a break for choosing emotional comfort of dividends over the financially better choice, but I won't give him a break for doing so while still think he is being a savvy investor. When he comes to grips with that, when he stops citing really poor 'articles' because they give comfort to his poor choices, when he accepts that while his choices are his to make they aren't good choices, I'll give him a break.

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triceratop
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by triceratop » Fri Oct 06, 2017 8:59 pm

nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here? My gosh the guy is 23 years old and at least has
the sense to invest the inheritance from his mom in high quality stocks. I bought my first stock mutual fund at age 25 in a taxable account, and a very tax inefficient fund at that. His choice of High Yield Index and Dividend Appreciation Index is miles more tax efficient than my first mutual fund. I was probably 28 years old when I bought my first individual stock.

As a young investor, I was actually pretty ultraconservative. My IRA was in bank CDs until a friend went into the brokerage business. I bought my first stock, AST Research from him and from there it was off to the races. Even then, I bought three zero coupon treasuries paying about 8% and an FDIC Insured Certificate of Deposit. I gradually became more aggressive as I experienced one of the great bull markets of all time.

Snarlyjack started out with Vanguard and I started out with a no-load mutual fund and later with a stockbroker. I didn't start investing in index funds until the mid-1990's. My first index fund was purchased at about age 36. All I can say is that I did a lot of things that were not optimal from a Boglehead perspective. He will make mistakes and learn just as I did, and I suspect as other forum members did.

So the guy is miles beyond where I was at age 23. At his age, I was a poor college student with no money. I guess that is why I picked a mutual fund with no minimum investment, that seemed a good match for someone with no money.
I am 25.

I try to be very frank and honest with my advice and thoughts precisely because I know how much money he may be leaving on the table. How do I know? I was where he was 3 years ago. But I relentlessly learned until I understood how things worked. My gosh, you can probably find some earlier posts of mine on the forum where i am stunningly ignorant. I'm most proud of those posts, because it shows how much I've learned since. The fact is that even marginal improvements in portfolio strategy pay large, well, dividends 40 years down the road. I've been over this with snarlyjack and I hope to get him to realize His behavioral errors one day.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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TD2626
Posts: 519
Joined: Thu Mar 16, 2017 3:40 pm

Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Fri Oct 06, 2017 9:43 pm

avalpert wrote:
Fri Oct 06, 2017 8:19 pm
nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here?
No, we can't. I'll give him a break for choosing emotional comfort of dividends over the financially better choice, but I won't give him a break for doing so while still think he is being a savvy investor. When he comes to grips with that, when he stops citing really poor 'articles' because they give comfort to his poor choices, when he accepts that while his choices are his to make they aren't good choices, I'll give him a break.
I think we are arguing about whether the sky is blue or azure. The correct answer may be "azure" but it probably won't matter too much.

I did some backtesting using Portfolio Visualizer.

I modeled two portfolios. Both are 60/40 stock/bond allocations, with 1/3rd of stocks in Total International.

There are two differences between the "regular" Portfolio 1 and the "dividend-tilted" Portfolio 2.

First, portfolio 2 includes 10% of the Total Stock allocation in a dividend fund. Second, portfolio 2 uses Total Stock Index Investor Shares instead of Admiral Shares. I did this to roughly simulate a known, needless, small drag on the portfolio. The dividend yield fund has a 'tax drag", I am simulating that with a fee drag.

Code: Select all

Fund								Portfolio 1	Portfolio 2
Vanguard Total Stock Index Fund Admiral Shares			40
Vanguard Total Stock Index Fund Investor Shares					30
Vanguard High Dividend Yield Fund						10
Vanguard Total International Index Fund Investor Shares		20		20
Vanguard Total Bond Fund 					40		40
The backtest results are here: https://www.portfoliovisualizer.com/bac ... tion5_2=10

Out to two decimal places, both allocations had the same Sharpe ratio during the 10 years that Portfolio Visualizer had data for. The two portfolios tracked each other fairly well.

That being said, the tax drag in a dividend fund is not ideal, and it's harder to make the case for a dividend fund for someone who isn't withdrawing the dividends. If risks and returns of a dividend fund are identical, then the dividend fund would be best. However, this may not be the case. One could probably make a semi-realistic argument that the value tilt of a dividend fund could partially compensate for the tax drag (I don't necessarily agree with this argument, though).

Note that history is no guarantee and there are limits to backtesting.

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triceratop
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by triceratop » Fri Oct 06, 2017 10:03 pm

TD2626 wrote:
Fri Oct 06, 2017 9:43 pm
avalpert wrote:
Fri Oct 06, 2017 8:19 pm
nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here?
No, we can't. I'll give him a break for choosing emotional comfort of dividends over the financially better choice, but I won't give him a break for doing so while still think he is being a savvy investor. When he comes to grips with that, when he stops citing really poor 'articles' because they give comfort to his poor choices, when he accepts that while his choices are his to make they aren't good choices, I'll give him a break.
I think we are arguing about whether the sky is blue or azure. The correct answer may be "azure" but it probably won't matter too much.

I did some backtesting using Portfolio Visualizer.

I modeled two portfolios. Both are 60/40 stock/bond allocations, with 1/3rd of stocks in Total International.

There are two differences between the "regular" Portfolio 1 and the "dividend-tilted" Portfolio 2.

First, portfolio 2 includes 10% of the Total Stock allocation in a dividend fund. Second, portfolio 2 uses Total Stock Index Investor Shares instead of Admiral Shares. I did this to roughly simulate a known, needless, small drag on the portfolio. The dividend yield fund has a 'tax drag", I am simulating that with a fee drag.

Code: Select all

Fund								Portfolio 1	Portfolio 2
Vanguard Total Stock Index Fund Admiral Shares			40
Vanguard Total Stock Index Fund Investor Shares					30
Vanguard High Dividend Yield Fund						10
Vanguard Total International Index Fund Investor Shares		20		20
Vanguard Total Bond Fund 					40		40
The backtest results are here: https://www.portfoliovisualizer.com/bac ... tion5_2=10

Out to two decimal places, both allocations had the same Sharpe ratio during the 10 years that Portfolio Visualizer had data for. The two portfolios tracked each other fairly well.

That being said, the tax drag in a dividend fund is not ideal, and it's harder to make the case for a dividend fund for someone who isn't withdrawing the dividends. If risks and returns of a dividend fund are identical, then the dividend fund would be best. However, this may not be the case. One could probably make a semi-realistic argument that the value tilt of a dividend fund could partially compensate for the tax drag (I don't necessarily agree with this argument, though).

Note that history is no guarantee and there are limits to backtesting.
I don't really think this kind of testing is needed, or even helpful. You can calculate with mathematical precision what your losses would have been with a dividend tilt. There is no need for a backtest. What's more, if your goal is a value tilt there are more tax efficient ways to achieve that.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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TD2626
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Fri Oct 06, 2017 11:52 pm

triceratop wrote:
Fri Oct 06, 2017 10:03 pm
I don't really think this kind of testing is needed, or even helpful. You can calculate with mathematical precision what your losses would have been with a dividend tilt. There is no need for a backtest. What's more, if your goal is a value tilt there are more tax efficient ways to achieve that.
It's worth noting that in my backtest above, the max drawdown was slightly larger for the portfolio with the dividend tilt. There is no evidence that dividend investments can provide the kind of reduction in drawdowns that high-grade bonds can; this is a common misconception.




I like dividend tilts, mostly for convenience, but feel I am learning a lot from this thread.

I have a few questions about the theory behind growth investing:

1. If a company never distributes dividends in its entire history from startup to bankruptcy, did it ever return value to shareholders or are the only people who made money those who sold to "greater fools"?

2. Does the answer to the above question change if the company did buybacks?

3. Isn't the value of a stock based on the discounted value of its future dividend stream (dividend discount model)? How does one value a stock that doesn't pay dividends? I guess that there may be a residual value of the company that one would get if it were wound down... a "shareholder's equity" value... and some non-dividend companies may have value based on hopes that they pay a dividend in the future or make a large payout when merged or sold. However, where is the value in owning something that doesn't reliably, directly pay the the investor?

4. Can you set up regular sales from stocks to realize capital gains using Spec ID? Isn't this instead a difficult, manual process that may in some cases involve transaction fees, looking up cost basis records, dealing with a 1099-B, mailing in stock certificates, etc? Does the obvious convenience of a dividend strategy outweigh the costs of the tax drag? Processing a sale can be very difficult, costly, and time-consuming especially if reinvestment has occurred for many years and there are hundreds of share lots.

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kingsnake
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Location: midwest

Re: Dividends vs. Capital Gains for Spending Needs?

Post by kingsnake » Sat Oct 07, 2017 8:21 am

dbr wrote:
Fri Oct 06, 2017 5:10 pm
kingsnake wrote:
Fri Oct 06, 2017 5:08 pm
The 3 fund portfolio still kicks out a lot of dividends....I'd like to have enough principle to live off dividends some day. We'll see.
Why? That might require you to work longer and save more than you really need to. It might also cause you to spend down your retirement too fast. Dividend payouts are not the measure of the best use of assets in retirement.
The 3 fund portfolio still kicks out a lot of dividends. I'd like to have enough from interest and dividends, using the 3 fund portfolio, to live off someday. Why? I guess it is psychological. I think I can do it or come close and still retire at age 50 if I want, as I'm lucky to be a high income earner and decent saver.

snarlyjack
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Location: Montana

Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 9:06 am

Good Morning Everyone,

I guess were going back into this conversation (dividends).

(I would like to say that I' am not the only one who likes dividends,
in the marketplace, their are Millions of people who look for dividends.
Why do you think that Vanguard offers these 3 funds, Dividend Appreciation,
Dividend Growth & High Dividend Yield Funds with $Billions of money invested
in them). Also, I' am not taking this personally & I can handle the heat.
When it's all said & done I'll still have my portfolio (70 years from now)
because I won't have to sell off my funds. That's the goal. But to be honest
a combination of funds is probably the best way to go...

Here is a video from Kevin O' Leary about dividends. Enjoy...

https://www.bing.com/videos/search?q=ke ... ORM=VRDGAR

goingup
Posts: 2778
Joined: Tue Jan 26, 2010 1:02 pm

Re: Dividends vs. Capital Gains for Spending Needs?

Post by goingup » Sat Oct 07, 2017 9:14 am

Phineas J. Whoopee wrote:
Fri Oct 06, 2017 6:40 pm
goingup wrote:
Fri Oct 06, 2017 6:21 pm
...
Funny, I knew exactly what kingsnake meant but I have no idea what you're trying to convey. :oops: If he/she had said, "My 3-fund portfolio kicks out a lot of dividends which I'd like to use to fund my retirement someday," would that have been acceptable?
Hi goingup.

Nothing kingsnake posted was unacceptable. I stated clearly, at the beginning and again at the end, that since I had posted a short time ago we can explain the difference between principal and capital whenever necessary, I was giving it a try.

If I may be excused for quoting myself:
Phineas J. Whoopee wrote:...
My having posted, a short time ago, a suggestion that we can explain the difference between principal and capital whenever necessary, I'd like to give it a try. I'm not picking on you personally. You just happen to have posted in the right place at the right time. :happy
...
Phineas J. Whoopee wrote:...
With practice it probably will get quicker and easier to explain the difference between the broader term capital, and the narrower one principal, but this is my initial game attempt.

Thanks for providing me with the opportunity, and I wish you all the best, kingsnake.
...
Was what I wrote, carefully signposted at both the beginning and at the end, unacceptable in your eyes?

PJW
OK. Reread your post and I understand your mission now. My sense is that trying to clarify these terms (principal and capital) may not especially deepen the understanding of the nature of dividends, but it could just be that I'm a poor student on this topic. :D

KlangFool
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 10:13 am

TD2626 wrote:
Fri Oct 06, 2017 11:52 pm
triceratop wrote:
Fri Oct 06, 2017 10:03 pm
I don't really think this kind of testing is needed, or even helpful. You can calculate with mathematical precision what your losses would have been with a dividend tilt. There is no need for a backtest. What's more, if your goal is a value tilt there are more tax efficient ways to achieve that.
It's worth noting that in my backtest above, the max drawdown was slightly larger for the portfolio with the dividend tilt. There is no evidence that dividend investments can provide the kind of reduction in drawdowns that high-grade bonds can; this is a common misconception.




I like dividend tilts, mostly for convenience, but feel I am learning a lot from this thread.

I have a few questions about the theory behind growth investing:
https://www.amazon.com/Your-Complete-Gu ... +investing

TD2626,

In order for a certain kind of investing to work, you need 2 things:

A) The stock is doing better than expected.

B) You can buy the stock at a bargain.

The opposite of growth investing is value-based investing. You can read the above book.

The reason why value-based investing works and growth investing is (A) and (B). People like the growth stock.

1) They have an unrealistic high expectation of the growth. So, it is hard for the stock to beat expectation continuously.

2) The stock is priced according to the high expectation. So, you do not get a bargain.

Because of (1) and (2), growth investing does not work.

KlangFool

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nedsaid
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by nedsaid » Sat Oct 07, 2017 10:39 am

triceratop wrote:
Fri Oct 06, 2017 8:59 pm
nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here? My gosh the guy is 23 years old and at least has
the sense to invest the inheritance from his mom in high quality stocks. I bought my first stock mutual fund at age 25 in a taxable account, and a very tax inefficient fund at that. His choice of High Yield Index and Dividend Appreciation Index is miles more tax efficient than my first mutual fund. I was probably 28 years old when I bought my first individual stock.

As a young investor, I was actually pretty ultraconservative. My IRA was in bank CDs until a friend went into the brokerage business. I bought my first stock, AST Research from him and from there it was off to the races. Even then, I bought three zero coupon treasuries paying about 8% and an FDIC Insured Certificate of Deposit. I gradually became more aggressive as I experienced one of the great bull markets of all time.

Snarlyjack started out with Vanguard and I started out with a no-load mutual fund and later with a stockbroker. I didn't start investing in index funds until the mid-1990's. My first index fund was purchased at about age 36. All I can say is that I did a lot of things that were not optimal from a Boglehead perspective. He will make mistakes and learn just as I did, and I suspect as other forum members did.

So the guy is miles beyond where I was at age 23. At his age, I was a poor college student with no money. I guess that is why I picked a mutual fund with no minimum investment, that seemed a good match for someone with no money.
I am 25.

I try to be very frank and honest with my advice and thoughts precisely because I know how much money he may be leaving on the table. How do I know? I was where he was 3 years ago. But I relentlessly learned until I understood how things worked. My gosh, you can probably find some earlier posts of mine on the forum where i am stunningly ignorant. I'm most proud of those posts, because it shows how much I've learned since. The fact is that even marginal improvements in portfolio strategy pay large, well, dividends 40 years down the road. I've been over this with snarlyjack and I hope to get him to realize His behavioral errors one day.
I did not post this to slam you, your posts are excellent. We tend to take financial knowledge for granted around here, we forget how little many Americans really know about personal finance and investing. I do "think aloud" here on the forum and put things out there that I have been thinking about even if I haven't thought everything through. We shouldn't be afraid to post thinking everything has to be 100% perfect before we post. The back and forth is how we all learn.

It does take courage to put your personal finances out on a forum and face the inevitable criticism. I try to encourage people and focus on what they have done right. The last thing we want is for people to think they are shown to be foolish and be so embarrassed that they don't post again.

I've taken criticism for taking a rather relaxed attitude towards a lot of things, I am not ancient but I have seen a lot of things come and go. It is getting harder for me to get so worked up over certain things knowing that a lot of things are going to change anyways. Last night, I was thinking about the changes in the tax law over the years including the short term, medium term, and long term capital gains fiasco that lasted a year. Also was thinking about the various investment fads that have come and gone.

I have read your posts over a couple of years and they have been good. You did really great work with your worksheet comparing different mutual funds and their tax efficiency. You took a lot of time showing the cumulative effects of taxes over many years. I think you should be proud of your work. And yes, we all learn over time. I know I have learned a lot here.
A fool and his money are good for business.

retire57
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by retire57 » Sat Oct 07, 2017 10:53 am

kingsnake wrote:
Sat Oct 07, 2017 8:21 am
dbr wrote:
Fri Oct 06, 2017 5:10 pm
kingsnake wrote:
Fri Oct 06, 2017 5:08 pm
The 3 fund portfolio still kicks out a lot of dividends....I'd like to have enough principle to live off dividends some day. We'll see.
Why? That might require you to work longer and save more than you really need to. It might also cause you to spend down your retirement too fast. Dividend payouts are not the measure of the best use of assets in retirement.
The 3 fund portfolio still kicks out a lot of dividends. I'd like to have enough from interest and dividends, using the 3 fund portfolio, to live off someday. Why? I guess it is psychological. I think I can do it or come close and still retire at age 50 if I want, as I'm lucky to be a high income earner and decent saver.
That's exactly what we do. We are retired and able to supplement our pensions nicely with VTSAX and VTIAX dividends. As for the tax implications, we are in the 15% bracket and pay taxes on the dividends anyway so ... why not spend them? We didn't chase dividends during the accumulation phase - it just worked out this way. All the calculations and back-testing in the world is meaningless until you reach the distribution phase. There is no one right answer for everyone.

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nedsaid
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by nedsaid » Sat Oct 07, 2017 11:05 am

avalpert wrote:
Fri Oct 06, 2017 8:19 pm
nedsaid wrote:
Fri Oct 06, 2017 7:15 pm
avalpert wrote:
Thu Oct 05, 2017 3:28 pm
snarlyjack wrote:
Thu Oct 05, 2017 3:15 pm
I really don't want to get into this argument again.

However, I would like to point out some items to
(Physician On Fire) for future reference.

1). Not everyone lives in California.
2). Not everyone is in the 25% tax bracket.
3). Not every State imposes high taxes on dividends.
4). Everyone is not a Doctor in a high tax bracket.
5). I consider myself a pretty "savvy" investor.
6). This was a really biased/slanted article.
7). I would not invest in Berkshire Hathaway because
they do not pay a dividend & I love Warren Buffett.

Ok...You can carry on now...Thanks for letting me rant.
I'd suggest that statement #7 demonstrates that statement #5 is incorrect.
My gosh, can't we give Snarlyjack a break here?
No, we can't. I'll give him a break for choosing emotional comfort of dividends over the financially better choice, but I won't give him a break for doing so while still think he is being a savvy investor. When he comes to grips with that, when he stops citing really poor 'articles' because they give comfort to his poor choices, when he accepts that while his choices are his to make they aren't good choices, I'll give him a break.
Oh man, do you ever read your own posts? The tone of your posts is utterly amazing.
A fool and his money are good for business.

rkhusky
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by rkhusky » Sat Oct 07, 2017 11:25 am

retire57 wrote:
Sat Oct 07, 2017 10:53 am
As for the tax implications, we are in the 15% bracket and pay taxes on the dividends anyway so ... why not spend them?
If you invest in Total Stock Market, whose dividends are mostly qualified, isn't the tax rate essentially zero in the 15% bracket?

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PhysicianOnFIRE
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by PhysicianOnFIRE » Sat Oct 07, 2017 11:54 am

rkhusky wrote:
Sat Oct 07, 2017 11:25 am
retire57 wrote:
Sat Oct 07, 2017 10:53 am
As for the tax implications, we are in the 15% bracket and pay taxes on the dividends anyway so ... why not spend them?
If you invest in Total Stock Market, whose dividends are mostly qualified, isn't the tax rate essentially zero in the 15% bracket?
Correct. I believe VTSAX was 93% qualified last year. In the 15% federal income tax bracket, those qualified dividends are tax free at the federal level. There would still be state income tax on the dividends in most states, though.

jebmke
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by jebmke » Sat Oct 07, 2017 12:01 pm

PhysicianOnFIRE wrote:
Sat Oct 07, 2017 11:54 am
rkhusky wrote:
Sat Oct 07, 2017 11:25 am
retire57 wrote:
Sat Oct 07, 2017 10:53 am
As for the tax implications, we are in the 15% bracket and pay taxes on the dividends anyway so ... why not spend them?
If you invest in Total Stock Market, whose dividends are mostly qualified, isn't the tax rate essentially zero in the 15% bracket?
Correct. I believe VTSAX was 93% qualified last year. In the 15% federal income tax bracket, those qualified dividends are tax free at the federal level. There would still be state income tax on the dividends in most states, though.
Also, if you have other income, there is that 30% marginal rate that jumps in as the income rises. Dividends contribute to that stack so for people doing ROTH conversions, dividends reduces headroom for that in some cases. In my case, with state taxes ~8% that means my marginal rate can jump to 38% due to dividends.
When you discover that you are riding a dead horse, the best strategy is to dismount.

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TD2626
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 12:32 pm

KlangFool wrote:
Sat Oct 07, 2017 10:13 am
TD2626 wrote:
Fri Oct 06, 2017 11:52 pm
triceratop wrote:
Fri Oct 06, 2017 10:03 pm
I don't really think this kind of testing is needed, or even helpful. You can calculate with mathematical precision what your losses would have been with a dividend tilt. There is no need for a backtest. What's more, if your goal is a value tilt there are more tax efficient ways to achieve that.
It's worth noting that in my backtest above, the max drawdown was slightly larger for the portfolio with the dividend tilt. There is no evidence that dividend investments can provide the kind of reduction in drawdowns that high-grade bonds can; this is a common misconception.




I like dividend tilts, mostly for convenience, but feel I am learning a lot from this thread.

I have a few questions about the theory behind growth investing:
https://www.amazon.com/Your-Complete-Gu ... +investing

TD2626,

In order for a certain kind of investing to work, you need 2 things:

A) The stock is doing better than expected.

B) You can buy the stock at a bargain.

The opposite of growth investing is value-based investing. You can read the above book.

The reason why value-based investing works and growth investing is (A) and (B). People like the growth stock.

1) They have an unrealistic high expectation of the growth. So, it is hard for the stock to beat expectation continuously.

2) The stock is priced according to the high expectation. So, you do not get a bargain.

Because of (1) and (2), growth investing does not work.

KlangFool
So is the conclusion in your view that one should not invest heavily in growth stocks solely because they often don't pay dividends to avoid the tax drag of the dividends, and that one should instead consider either Total Stock or a small value/dividend tilt? (Of course, "divided stock fund" is a imperfect proxy for "value stock fund")

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 12:37 pm

TD2626 wrote:
Sat Oct 07, 2017 12:32 pm
KlangFool wrote:
Sat Oct 07, 2017 10:13 am
TD2626 wrote:
Fri Oct 06, 2017 11:52 pm
triceratop wrote:
Fri Oct 06, 2017 10:03 pm
I don't really think this kind of testing is needed, or even helpful. You can calculate with mathematical precision what your losses would have been with a dividend tilt. There is no need for a backtest. What's more, if your goal is a value tilt there are more tax efficient ways to achieve that.
It's worth noting that in my backtest above, the max drawdown was slightly larger for the portfolio with the dividend tilt. There is no evidence that dividend investments can provide the kind of reduction in drawdowns that high-grade bonds can; this is a common misconception.




I like dividend tilts, mostly for convenience, but feel I am learning a lot from this thread.

I have a few questions about the theory behind growth investing:
https://www.amazon.com/Your-Complete-Gu ... +investing

TD2626,

In order for a certain kind of investing to work, you need 2 things:

A) The stock is doing better than expected.

B) You can buy the stock at a bargain.

The opposite of growth investing is value-based investing. You can read the above book.

The reason why value-based investing works and growth investing is (A) and (B). People like the growth stock.

1) They have an unrealistic high expectation of the growth. So, it is hard for the stock to beat expectation continuously.

2) The stock is priced according to the high expectation. So, you do not get a bargain.

Because of (1) and (2), growth investing does not work.

KlangFool
So is the conclusion in your view that one should not invest heavily in growth stocks solely because they often don't pay dividends to avoid the tax drag of the dividends, and that one should instead consider either Total Stock or a small value/dividend tilt? (Of course, "divided stock fund" is a imperfect proxy for "value stock fund")
Yes on total stock and small value tilt. No on the dividend.

<<(Of course, "divided stock fund" is a imperfect proxy for "value stock fund")>>

Why go for the proxy when you get the real thing?

<<So is the conclusion in your view that one should not invest heavily in growth stocks solely because they often don't pay dividends to avoid the tax drag of the dividends,>>

It has nothing to do with the dividend. The growth stock is a lousy investment because people overpay or bid up the price of the growth stock beyond reasonable values. They are overpriced most of the times.

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 12:42 pm

jebmke wrote:
Sat Oct 07, 2017 12:01 pm
PhysicianOnFIRE wrote:
Sat Oct 07, 2017 11:54 am
rkhusky wrote:
Sat Oct 07, 2017 11:25 am
retire57 wrote:
Sat Oct 07, 2017 10:53 am
As for the tax implications, we are in the 15% bracket and pay taxes on the dividends anyway so ... why not spend them?
If you invest in Total Stock Market, whose dividends are mostly qualified, isn't the tax rate essentially zero in the 15% bracket?
Correct. I believe VTSAX was 93% qualified last year. In the 15% federal income tax bracket, those qualified dividends are tax free at the federal level. There would still be state income tax on the dividends in most states, though.
Also, if you have other income, there is that 30% marginal rate that jumps in as the income rises. Dividends contribute to that stack so for people doing ROTH conversions, dividends reduces headroom for that in some cases. In my case, with state taxes ~8% that means my marginal rate can jump to 38% due to dividends.
I'm not quite sure but could this be the source of some confusion:
The 15% income bracket pays 0% federal qualified dividend tax... but they (retire57) didn't say they were in the 15% income bracket.

They may be in the 15% dividend/cap gain bracket, which includes the 25% income bracket among others.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by patrick013 » Sat Oct 07, 2017 12:52 pm

TD2626 wrote:
Fri Oct 06, 2017 9:43 pm

There are two differences between the "regular" Portfolio 1 and the "dividend-tilted" Portfolio 2.

First, portfolio 2 includes 10% of the Total Stock allocation in a dividend fund.
Not going to work. You need a dividend fund that is yield weighted or equal
weighted. Unfortunately few if any exact methodologies are available with
long histories, except the ones used in the dividend fund studies. Try SPYD,
SPHD, or SDOG for about 10 or 20 years in the future in a Roth. They're
somewhat close to the study stock selections. I would.
age in bonds, buy-and-hold, 10 year business cycle

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by retire57 » Sat Oct 07, 2017 1:29 pm

[/quote]
I'm not quite sure but could this be the source of some confusion:
The 15% income bracket pays 0% federal qualified dividend tax... but they (retire57) didn't say they were in the 15% income bracket.

They may be in the 15% dividend/cap gain bracket, which includes the 25% income bracket among others.
[/quote]

Yes - 15% income tax bracket and proud of it!!! :D

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 1:33 pm

I went on the internet & found out the
15% Federal Income Tax level is $37,950.

No taxes are due on dividends if you earn less
than this amount. However, some State Tax
might have to be paid (depends on the State).

When I did my taxes last year (2016) because I earned
less than $37,950 my dividends were Federally Tax free.
And I received a income tax refund on what I did pay
on my employers payroll taxes.

Everyone's situation is different. (Is their a CPA in
the house?) It would seem to me that if your retired
with a low retirement income dividends would be
very favorable.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 1:33 pm

KlangFool wrote:
Sat Oct 07, 2017 12:37 pm

<<(Of course, "divided stock fund" is a imperfect proxy for "value stock fund")>>

Why go for the proxy when you get the real thing?
Because the dividend fund can do double duty and the value index fund can't.

Basically, the dividend fund is a "double imperfect proxy" - it's an imperfect proxy for a value tilt and an imperfect proxy for a variable withdrawal scheme. The dividend fund is sort of a jack of all trades and a master of none. It has tax drag but also has the convenience of regular income without the hassle, paperwork, and fees of a sale - plus it has somewhat of a value tilt.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 1:40 pm

TD2626 wrote:
Sat Oct 07, 2017 1:33 pm
KlangFool wrote:
Sat Oct 07, 2017 12:37 pm

<<(Of course, "divided stock fund" is a imperfect proxy for "value stock fund")>>

Why go for the proxy when you get the real thing?
Because the dividend fund can do double duty and the value index fund can't.

Basically, the dividend fund is a "double imperfect proxy" - it's an imperfect proxy for a value tilt and an imperfect proxy for a variable withdrawal scheme. The dividend fund is sort of a jack of all trades and a master of none. It has tax drag but also has the convenience of regular income without the hassle, paperwork, and fees of a sale - plus it has somewhat of a value tilt.
TD2626,

Basically, it is good for nothing. So, why do it and pay a lot more taxes in the process?

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by spdoublebass » Sat Oct 07, 2017 1:48 pm

snarlyjack wrote:
Sat Oct 07, 2017 1:33 pm
I went on the internet & found out the
15% Federal Income Tax level is $37,950.

No taxes are due on dividends if you earn less
than this amount. However, some State Tax
might have to be paid (depends on the State).

When I did my taxes last year (2016) because I earned
less than $37,950 my dividends were Federally Tax free.
And I received a income tax refund on what I did pay
on my employers payroll taxes.

Everyone's situation is different. (Is their a CPA in
the house?) It would seem to me that if your retired
with a low retirement income dividends would be
very favorable.
Maybe I'm missing something, but from what I've read on this forum, people aren't frowning upon holding dividend funds in retirement, they are saying in accumulation they shouldn't hold them over say TSM.

As a novice, I understand this, but confused as to when one would add the dividend fund. I get why one doesn't NEED to add the fund though.
Resist much, obey little.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 1:50 pm

snarlyjack wrote:
Sat Oct 07, 2017 1:33 pm
I went on the internet & found out the
15% Federal Income Tax level is $37,950.

No taxes are due on dividends if you earn less
than this amount. However, some State Tax
might have to be paid (depends on the State).

When I did my taxes last year (2016) because I earned
less than $37,950 my dividends were Federally Tax free.
And I received a income tax refund on what I did pay
on my employers payroll taxes.

Everyone's situation is different. (Is their a CPA in
the house?) It would seem to me that if your retired
with a low retirement income dividends would be
very favorable.
snarlyjack,

Versus getting tax credit aka tax refund if you do not receive that dividend? Aka, negative tax?

It is easy to calculate and find out the number. There is no point arguing about this.

I had Wellington Fund and Vanguard Life Strategy Moderate Growth fund in my taxable account for many years. I argued against many folks about the tax efficiency of my approach. I claimed that it didn't matter. Then, one day, I stopped arguing and calculated. I cannot argue against the number. I saved thousand in taxes every year by investing more tax efficiently.

I have been there. It is a simple tax calculation to find out the answer if you want to.

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 2:02 pm

KlangFool,

I can give you (some) of my reasons for liking dividends.

1). Since both of are parents are gone (I' am on my own &
can't borrow money from them in a emergency). In a emergency
I can use my credit card & pay if off with the next dividend payment.
(Financial Security).

2). Compounding, the 8th wonder of the world. When I reinvest
my dividend I get more shares. Since dividend payments are based on
the number of shares I have my dividends keep growing by the number
of shares that I have. So the fund is compounding out faster.

3). The "Big One" I don't need to sell off a portion of the fund &
I' am not stuck with the 4% Trinity Studies. However, I also have
the option to liquidate shares at anytime (just like everyone else).
It gives me more options. And since in my case they are tax free
why not use the options to my advantage.

4). Once my dividends are greater than my expenses I' am essentially free.
It gives me greater options. I' am not always checking my account values
I follow the trend line of the dividend payments. I' am much calmer &
less stressed about the stock market. I could care less what the
"talking heads on t.v. say". My life is serene...

KlangFool
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Joined: Sat Oct 11, 2008 12:35 pm

Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 2:18 pm

snarlyjack wrote:
Sat Oct 07, 2017 2:02 pm
KlangFool,

I can give you (some) of my reasons for liking dividends.

1). Since both of are parents are gone (I' am on my own &
can't borrow money from them in a emergency). In a emergency
I can use my credit card & pay if off with the next dividend payment.
(Financial Security).

2). Compounding, the 8th wonder of the world. When I reinvest
my dividend I get more shares. Since dividend payments are based on
the number of shares I have my dividends keep growing by the number
of shares that I have. So the fund is compounding out faster.

3). The "Big One" I don't need to sell off a portion of the fund &
I' am not stuck with the 4% Trinity Studies. However, I also have
the option to liquidate shares at anytime (just like everyone else).
It gives me more options. And since in my case they are tax free
why not use the options to my advantage.

4). Once my dividends are greater than my expenses I' am essentially free.
It gives me greater options. I' am not always checking my account values
I follow the trend line of the dividend payments. I' am much calmer &
less stressed about the stock market. I could care less what the
"talking heads on t.v. say". My life is serene...
snarlyjack,

You can accomplish all of the above with a normal tax-efficient stock market index fund. Plus, you probably will pay a lot less tax. I have been there. Yes, I invested in the high yield corporate bond fund for the same reason about 10+ years ago. The numbers do not work out.

You do not have to change your mind. Just do the calculation and let the number tell you.

It took me a few years to work this out.

<<And since in my case they are tax free>.

Why aim for tax-free when you can get a tax refund via tax credit? If the government want to give you money, why do you choose to refuse it?

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 2:40 pm

KlangFool,

Nice meeting you by the way.

I follow JLCollins (JLCollins.com) Taylor has posted his
web site quite a few times. (JLCollins is very good, by the way).
And, I agree with him about 98-99%. Basically what JLCollins
suggest is put 100% of your monies into the TSM fund & when your
dividends are above your expenses your free. Which I agree with.
The problem is the TSM fund is paying 1.8% dividend. (Same strategy
different fund.)

Let's say I have $1.0 million dollars:

1). TSM fund (1.8%) = $18,000 a year to live on.
2). High Dividend Yield fund (3.0%) = $30,000 a year to live on.

If you need the income to live on & your not paying any attention
to your fund value & just using dividends which fund would you pick?
JLCollins is also trying to avoid the 4% Trinity Study (I totality agree).
So the strategy is the same...only a different fund. Just a slight twist
on a old idea...(not a new idea).

Physician On Fire knows JLCollins because I've read his articles.
Physician on Fire is very, very good! Here is to you Physician On Fire :sharebeer

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 3:23 pm

snarlyjack wrote:
Sat Oct 07, 2017 2:40 pm
KlangFool,

Nice meeting you by the way.

I follow JLCollins (JLCollins.com) Taylor has posted his
web site quite a few times. (JLCollins is very good, by the way).
And, I agree with him about 98-99%. Basically what JLCollins
suggest is put 100% of your monies into the TSM fund & when your
dividends are above your expenses your free. Which I agree with.
The problem is the TSM fund is paying 1.8% dividend. (Same strategy
different fund.)

Let's say I have $1.0 million dollars:

1). TSM fund (1.8%) = $18,000 a year to live on.
2). High Dividend Yield fund (3.0%) = $30,000 a year to live on.

If you need the income to live on & your not paying any attention
to your fund value & just using dividends which fund would you pick?
JLCollins is also trying to avoid the 4% Trinity Study (I totality agree).
So the strategy is the same...only a different fund. Just a slight twist
on a old idea...(not a new idea).

Physician On Fire knows JLCollins because I've read his articles.
Physician on Fire is very, very good! Here is to you Physician On Fire :sharebeer
snarlyjack,

Why do you need to create a fictitious example? Why would it matter? The only relevant issue is your own specific circumstance. If you are interested, start your own topic and show us your number. Do your own calculation and find out what makes the most sense for you.

This one item might worth a few thousand to you. It did for me. You should be interested in making a few thousand extra every year by spending a few hours.

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 3:38 pm

snarlyjack wrote:
Sat Oct 07, 2017 2:40 pm
KlangFool,

Nice meeting you by the way.

I follow JLCollins (JLCollins.com) Taylor has posted his
web site quite a few times. (JLCollins is very good, by the way).
And, I agree with him about 98-99%. Basically what JLCollins
suggest is put 100% of your monies into the TSM fund & when your
dividends are above your expenses your free. Which I agree with.
The problem is the TSM fund is paying 1.8% dividend. (Same strategy
different fund.)

Let's say I have $1.0 million dollars:

1). TSM fund (1.8%) = $18,000 a year to live on.
2). High Dividend Yield fund (3.0%) = $30,000 a year to live on.

If you need the income to live on & your not paying any attention
to your fund value & just using dividends which fund would you pick?
JLCollins is also trying to avoid the 4% Trinity Study (I totality agree).
So the strategy is the same...only a different fund. Just a slight twist
on a old idea...(not a new idea).

Physician On Fire knows JLCollins because I've read his articles.
Physician on Fire is very, very good! Here is to you Physician On Fire :sharebeer
This is like the perfect example of why dividend-focused strategies are bad ideas - even when a particular strategy isn't an inherently bad idea (using TSM's dividend yield to set a very conservative withdrawal rate for your portfolio) someone who doesn't understand the strategy yet thinks they are savvy investors will use it as a justification to do something which is a bad idea (chasing dividend yield and the increased risk that comes with that approach to justify a still conservative withdrawal level that could be had from TSM without the risk).

Hopefully all this will sink in for you before the tax costs of switching out of your bad choices is too severe.

snarlyjack
Posts: 475
Joined: Fri Aug 28, 2015 12:44 pm
Location: Montana

Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 3:53 pm

KlangFool,

There is nothing "fictitious" in my example at all.

If you go through my old posts I have divulged my
account values. But I'll do it again.

Tms--$250,000 x (1.8%) = $4,500. (Example).
HDY--$250,000 x (3.0%) = $7,500. (Example).

Now this isn't (correct) because I have diversified
out a bit. The bottom display is approximately 100% correct (the numbers fluctuate).

50% High Dividend Yield Fund ($125,000) x 3% = $3,750.
50% Dividend Appreciation Fund ($125,000) x 1.9% = $2,375.
10% cd's ($20,000) x 1.25% = $250. (local credit union).
Not including, Roth Ira, 100% LifeStrategy Fund.
My total dividends (approx.) $6,375 year or approx. $531. month.

I've always been very open about my account values.
When my Mom died I received $250,000 in Life Insurance.
This is why I really started reading Bogleheads & other articles.
I do have a vested interest in this...& I want to make the best decisions possible...

SGM
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Re: Dividends vs. Capital Gains for Spending Needs?

Post by SGM » Sat Oct 07, 2017 4:04 pm

The "dividend puzzle "will be with us a long time, also why do investors prefer dividends when capital gains are better when you consider taxation. Reaching for yield can be a disastrous mistake as others have pointed out.

It is difficult to understand that capital gains are preferential in taxable accounts given that so many others consider dividends to be freebies, including advisors, authors and investors. I see and hear recommendations for dividend stocks all the time. Dividends are seductive. It is a good idea to investigate this argument fully and repeatedly until one understands both sides of the issue. There may be some utility to preferring spending dividends only, but one needs to be open to understanding why it is not the most rational choice. Still for utility one may prefer spending dividends only. Just try to understand why it is not considered to be the most rational thing to do in a taxable account. And as many have wisely stated do not reach for yield. Best of luck BHs. :)

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by triceratop » Sat Oct 07, 2017 4:14 pm

snarlyjack wrote:
Sat Oct 07, 2017 2:02 pm
KlangFool,

I can give you (some) of my reasons for liking dividends.

1). Since both of are parents are gone (I' am on my own &
can't borrow money from them in a emergency). In a emergency
I can use my credit card & pay if off with the next dividend payment.
(Financial Security).

2). Compounding, the 8th wonder of the world. When I reinvest
my dividend I get more shares. Since dividend payments are based on
the number of shares I have my dividends keep growing by the number
of shares that I have. So the fund is compounding out faster.

3). The "Big One" I don't need to sell off a portion of the fund &
I' am not stuck with the 4% Trinity Studies. However, I also have
the option to liquidate shares at anytime (just like everyone else).
It gives me more options. And since in my case they are tax free
why not use the options to my advantage.

4). Once my dividends are greater than my expenses I' am essentially free.
It gives me greater options. I' am not always checking my account values
I follow the trend line of the dividend payments. I' am much calmer &
less stressed about the stock market. I could care less what the
"talking heads on t.v. say". My life is serene...
1) the same applies by selling tax-efficient equities held long-term and transferring out the funds after settlement (2 days).

2) This is false. Completely false. Compounding works on the dollars that you have. Your account value varies by a percentage of total value every day. Nothing more, nothing less. The only investing is total return investing.

3) You don't seem to get that by spending dividends you are withdrawing from the portfolio. Please re-read that sentence. Since you are withdrawing from the portfolio, you are absolutely subject to the 4% Trinity studies, or any other study on safe withdrawal rates. Also, your dividends are not tax free. As I've stated to you in past posts, your state tax on dividends is 6.5%. This is not an issue if you need to spend the dividends anyway, but if you're reinvesting the dividends it hurts you.

4) The same is true for tax-efficient stock index funds. You simply sell shares. By the way, dividends can absolutely be cut so it isn't as if you're immune to the stock market behavior. However it will take you less time to reach financial independence if you do not pursue a dividend strategy.

Please try to engage with the points I am raising. I do not need to read another "viewpoint" from a dividend promoter. I do not need another perspective. Just understand the points that I am raising and try to apply them to your situation.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Posts: 6962
Joined: Sat Oct 11, 2008 12:35 pm

Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 4:35 pm

snarlyjack wrote:
Sat Oct 07, 2017 3:53 pm
KlangFool,

There is nothing "fictitious" in my example at all.

If you go through my old posts I have divulged my
account values. But I'll do it again.

Tms--$250,000 x (1.8%) = $4,500. (Example).
HDY--$250,000 x (3.0%) = $7,500. (Example).

Now this isn't (correct) because I have diversified
out a bit. The bottom display is approximately 100% correct (the numbers fluctuate).

50% High Dividend Yield Fund ($125,000) x 3% = $3,750.
50% Dividend Appreciation Fund ($125,000) x 1.9% = $2,375.
10% cd's ($20,000) x 1.25% = $250. (local credit union).
Not including, Roth Ira, 100% LifeStrategy Fund.
My total dividends (approx.) $6,375 year or approx. $531. month.

I've always been very open about my account values.
When my Mom died I received $250,000 in Life Insurance.
This is why I really started reading Bogleheads & other articles.
I do have a vested interest in this...& I want to make the best decisions possible...
snarlyjack,

Start a new topic with your up-to-date information. Provide your income, tax bracket and so on. I have about 400K to 500K in my taxable account. It was worth a few thousand per year to me. It is probably worth that much to you too.

The key question that you should find out is the amount of tax and refund you could get with each option. You could either gain nothing and validate your decision. Or, you could earn a few thousand extra each year.

KlangFool

snarlyjack
Posts: 475
Joined: Fri Aug 28, 2015 12:44 pm
Location: Montana

Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 4:52 pm

Hello Triceratop & Avalpert,

Thank you for your help & suggestions.

I' am reinvesting all my dividends at this time to
build up the account as quickly as possible.
I' am also dollar cost averaging into all 3 funds (taxable
& IRA) each payday.

On #2, I must be completely confused? The dividend payment
is paid by the number of shares you have. The more shares the
better. (1 big share $100. is worth the same as 10 $10.00 shares).
Maybe...but the reason companies do splits is so they can keep
their share price down. They do this for a reason. Warren Buffett
share price is like, 1 share = $125,000. (I would not even consider that).
I consider compounding to be 1 cent + 1 cent +1 cent...to infinity. Or,
1+1=2, 2+1=3, 3+1=4 compounding out.

My biggest problem with TSM is the dividend 1.8% and most of
the stocks don't pay a dividend at all. As I look at it...the fund your
suggesting (TSM, a good fund) 3/4 of the stocks are non dividend paying.
So I' am kind of hummm.

avalpert
Posts: 6196
Joined: Sat Mar 22, 2008 4:58 pm

Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 7:39 pm

snarlyjack wrote:
Sat Oct 07, 2017 4:52 pm
My biggest problem with TSM is the dividend 1.8% and most of
the stocks don't pay a dividend at all.
Nope, your biggest problem continues to be you ascribe magical properties to dividends that don't exist.
I' am reinvesting all my dividends at this time to
build up the account as quickly as possible.
Right, so minimizing tax drag on forced payments of capital that you don't even want should be paramount to your strategy. You don't want dividends now it is hurting your goals, not helping.
I consider compounding to be 1 cent + 1 cent +1 cent...to infinity. Or,
1+1=2, 2+1=3, 3+1=4 compounding out.
That is addition, not compounding. Compound interest is earning interest on the previous interest that was added to the capital. Addition increases linearly, compounding leads to exponential increases.

This happens in savings accounts and certain fixed income securities - it does not happen with equities. Instead, a dividend is a payment from the capital of your asset, you are then reinvesting it into the asset thus keeping the value of the capital at the same level. The framing of dividend reinvesting as compounding returns as opposed to reinvesting returns of capital you didn't ask for (after paying taxes on it) is a common one which has the unfortunate side effect of confusing people into thinking dividends have magical powers that increase returns.

Reinvesting dividends is the same action as not selling shares, not reinvesting dividends (at leas in some asset in your portfolio not necessarily the asset it came from) is the same action as selling shares and taking a portfolio withdrawal.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TropikThunder » Sat Oct 07, 2017 7:51 pm

snarlyjack wrote:
Sat Oct 07, 2017 4:52 pm
My biggest problem with TSM is the dividend 1.8% and most of
the stocks don't pay a dividend at all
. As I look at it...the fund your
suggesting (TSM, a good fund) 3/4 of the stocks are non dividend paying.
So I' am kind of hummm.
If TSM has a 1.8% dividend, and VYM has a 3.0% dividend, than how did TSM outperform VYM over the past 10 years?
- VTSAX Vanguard Total Stock Market Admiral CAGR 8.01%
- VYM Vanguard High Dividend Yield CAGR 7.53%
https://www.portfoliovisualizer.com/bac ... sisResults

How in the world did VTSAX outperform when most of the stocks don't pay a dividend?

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by KlangFool » Sat Oct 07, 2017 7:59 pm

snarlyjack wrote:
Sat Oct 07, 2017 4:52 pm
Hello Triceratop & Avalpert,

Thank you for your help & suggestions.

I' am reinvesting all my dividends at this time to
build up the account as quickly as possible.
I' am also dollar cost averaging into all 3 funds (taxable
& IRA) each payday.

On #2, I must be completely confused? The dividend payment
is paid by the number of shares you have. The more shares the
better. (1 big share $100. is worth the same as 10 $10.00 shares).
Maybe...but the reason companies do splits is so they can keep
their share price down. They do this for a reason. Warren Buffett
share price is like, 1 share = $125,000. (I would not even consider that).
I consider compounding to be 1 cent + 1 cent +1 cent...to infinity. Or,
1+1=2, 2+1=3, 3+1=4 compounding out.

My biggest problem with TSM is the dividend 1.8% and most of
the stocks don't pay a dividend at all. As I look at it...the fund your
suggesting (TSM, a good fund) 3/4 of the stocks are non dividend paying.
So I' am kind of hummm.
snarlyjack,

If you have $1,000 worth of stock A and it pays out $30 in the dividend, stock A's price drop to $970. You have $970 in stock A and $30 in the dividend that you have to pay tax on. Even if you reinvest the dividend, you still have to pay tax on that $30 dividend.

You are in Montana with 6.9% state income tax. So, even if the dividend pays no Federal Income Tax, you still pay 6.9% state income tax. Please correct me if I am wrong.

KlangFool

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by FrugalProfessor » Sat Oct 07, 2017 8:30 pm

KlangFool wrote:
Fri Oct 06, 2017 9:50 am
FrugalProfessor wrote:
Thu Oct 05, 2017 3:49 pm
I loathe dividends and am perplexed by people's obsession with them. If a mutual fund or stock's dividend yield isn't high enough for your liking, sell some stock and create your home grown dividend.

For an investor with a multi decade investing horizon, I hate the drag caused by dividends, as shown by the following example.

$1 investment with 5% real return, 2% dividend yield, 20% tax rate on dividends (15% federal + 5% state), 20Y investing horizon.

No dividends.
FV = $1*(1+5%)^20 = $2.65

Dividends create a tax drag of 2%*20%=0.4%, causing the real return to drop from 5% to 4.6%.
FV = $1*(1+4.6%)^20 = $2.46

Dividends in this case have destroyed 7.3% of the potential value of the no-dividend stock (=1-$2.46/$2.65).
FrugalProfessor,

https://en.wikipedia.org/wiki/Qualified_dividend

Sorry to nitpick. There are the normal dividend and qualified dividend. They are taxed differently. Depending on the exact ETF and mutual fund, the amount/ratio of normal versus qualified dividend come into play as to how much tax that you do pay.

The list for qualified dividend ratio for Vanguard funds and ETF.

https://advisors.vanguard.com/VGApp/iip ... endfigures

KlangFool
Point taken. So my example provides a lower bound on the tax drag associated with dividends, as PoF mentions. This makes the case against dividends even stronger when considering the potential for non-qualified dividends.
I blog. My effective (not to be confused with statutory) MTR is 45% (fed + state, excluding payroll). I save $30k/year in taxes by maxing out deferrals. Taxes are the lowest hanging source of alpha.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by RAchip » Sat Oct 07, 2017 8:50 pm

"If you have $1,000 worth of stock A and it pays out $30 in the dividend, stock A's price drop to $970."

This is what I dont really believe. For example, ATT currently pays a dividend of $.49 per share quarterly or $1.96 per year. How can you prive ATT'a stock price would be $1.96 per share higher at the end of the year if they didnt pay dividends? I think the market would value ATT far below its current trading price if it didnt pay a dividend.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by triceratop » Sat Oct 07, 2017 8:55 pm

RAchip wrote:
Sat Oct 07, 2017 8:50 pm
"If you have $1,000 worth of stock A and it pays out $30 in the dividend, stock A's price drop to $970."

This is what I dont really believe. For example, ATT currently pays a dividend of $.49 per share quarterly or $1.96 per year. How can you prive ATT'a stock price would be $1.96 per share higher at the end of the year if they didnt pay dividends? I think the market would value ATT far below its current trading price if it didnt pay a dividend.
The statement only holds instantaneously at the moment of ex-dividend. It is an idealization meant to prove a point about the mechanics of dividend payment and asset pricing around the dividend date. It isn't applicable to discounting of dividend values or stock pricing in general.

By the way, Berkshire Hathaway has had spectacular returns despite not paying a dividend.
"To play the stock market is to play musical chairs under the chord progression of a bid-ask spread."

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 8:58 pm

RAchip wrote:
Sat Oct 07, 2017 8:50 pm
"If you have $1,000 worth of stock A and it pays out $30 in the dividend, stock A's price drop to $970."

This is what I dont really believe. For example, ATT currently pays a dividend of $.49 per share quarterly or $1.96 per year. How can you prive ATT'a stock price would be $1.96 per share higher at the end of the year if they didnt pay dividends? I think the market would value ATT far below its current trading price if it didnt pay a dividend.
Look at AT&T stock price on Thursday/Friday. It closed Thursday at 39.51 and opened Friday at 39.00 after going ex-divided with a .49 dividend. What else do you think drove the bulk of that price change?

To believe that the market doesn't adjust the price for distributed dividends is to believe the market would value a business that also has a barn full of gold bars at the same amount as an identical business that doesn't have that barn. Does that make sense?

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 9:16 pm

Some funds distribute capital gains and you have to pay taxes on those too. Selecting funds that trade infrequently or using Vanguard funds that funnel gains to in-kind etf redemptions can limit distributions. However, broad index funds (such as those at Fidelity) can distribute capital gains.

I agree that there is little short-term difference between a reinvested dividend and a share buyback. Over the long run, though, people invest in companies with an expectation of a return. I realize growth companies can grow and you get returns from rising share prices. But investors are assuming the company will eventually stop growing and start paying out, and isn't valuation predicated on that? If a company was committed to never paying a dividend untill bankruptcy, would it be worth it to own the stock? Or am I mistaken?

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 9:18 pm

I believe your right with your comments about dividends.

However, let me get this straight in my mind.

Dividends are Federal Tax free since I' am in the 15% Federal
Tax rate (with qualified dividends). However, I will owe 6.9%
State Tax on dividend income.

But if I liquidate share's I will pay a 20% Federal Capital Gains
Tax + State taxes.

It seems to me that getting dividends would be more tax
advantageous than capital gains tax of selling shares.

I wish the accumulation & dividends were tax free. But their
is a tax somewhere. On the dividends or on the sale. Am I
thinking correctly?

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 9:26 pm

snarlyjack wrote:
Sat Oct 07, 2017 9:18 pm
I believe your right with your comments about dividends.

However, let me get this straight in my mind.

Dividends are Federal Tax free since I' am in the 15% Federal
Tax rate (with qualified dividends). However, I will owe 6.9%
State Tax on dividend income.

But if I liquidate share's I will pay a 20% Federal Capital Gains
Tax + State taxes.
Nope, Federal taxes on capital gains and qualified dividends are the same (I don't know about your state law).

But when you liquidate a share not all of the money you receive, some is the basis, so for the same dollar amount raised via selling shares or dividends, even when dividends are 100% qualified, the taxable income is less with share sales.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 9:33 pm

TD2626 wrote:
Sat Oct 07, 2017 9:16 pm
Some funds distribute capital gains and you have to pay taxes on those too. Selecting funds that trade infrequently or using Vanguard funds that funnel gains to in-kind etf redemptions can limit distributions. However, broad index funds (such as those at Fidelity) can distribute capital gains.

I agree that there is little short-term difference between a reinvested dividend and a share buyback. Over the long run, though, people invest in companies with an expectation of a return. I realize growth companies can grow and you get returns from rising share prices. But investors are assuming the company will eventually stop growing and start paying out, and isn't valuation predicated on that? If a company was committed to never paying a dividend untill bankruptcy, would it be worth it to own the stock? Or am I mistaken?
Look at Berkshire Hathaway - they are committed to never returning cash to shareholders via dividends - has it been worth it to own the stock and do you think it will continue to be?

Real valuation is not predicated on returning cash via actual 'dividend payments' - there are other ways to return value to shareholders. It's important not to confuse the clean calculations of a model with simplifying assumptions with the real world it is modeling.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by snarlyjack » Sat Oct 07, 2017 9:34 pm

TropicThunder,

Hello.

I didn't say the Vanguard High Dividend Yield Index fund was
out performing the Total Stock Market fund. I said the
dividend yield was higher on the High Dividend Yield fund
(3.0% vs. 1.88%).

However, if you look at the 10 year chart comparing the
TSM vs. HDY the TSM fund isn't blowing it out of the water.
The TSM fund is a excellent fund, no question about it.
But so is the HDY fund. They are different. TSM is
everything, the HDY is big blue cap stocks.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 9:45 pm

avalpert wrote:
Sat Oct 07, 2017 9:33 pm
TD2626 wrote:
Sat Oct 07, 2017 9:16 pm
Some funds distribute capital gains and you have to pay taxes on those too. Selecting funds that trade infrequently or using Vanguard funds that funnel gains to in-kind etf redemptions can limit distributions. However, broad index funds (such as those at Fidelity) can distribute capital gains.

I agree that there is little short-term difference between a reinvested dividend and a share buyback. Over the long run, though, people invest in companies with an expectation of a return. I realize growth companies can grow and you get returns from rising share prices. But investors are assuming the company will eventually stop growing and start paying out, and isn't valuation predicated on that? If a company was committed to never paying a dividend untill bankruptcy, would it be worth it to own the stock? Or am I mistaken?
Look at Berkshire Hathaway - they are committed to never returning cash to shareholders via dividends - has it been worth it to own the stock and do you think it will continue to be?

Real valuation is not predicated on returning cash via actual 'dividend payments' - there are other ways to return value to shareholders.
How exactly would this work? If a company never pays a dividend, and goes bankrupt after decades of buybacks, aren't the only people who earned money those who sold to "greater fools"? I know it is worth something to own a fraction of an entity that has a lot of cash sitting around - but if that cash is only yours in theory, and will never be distributed in practice, what does that ownership amount to? I know Berkshire's total return history, and it's of course impressive - but aren't investors just valuing things based on the possibility that a distribution might be made in the future? Are there any good articles or research papers that you would recommend for learning more about the mechanics of how things work?

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by avalpert » Sat Oct 07, 2017 10:04 pm

TD2626 wrote:
Sat Oct 07, 2017 9:45 pm
avalpert wrote:
Sat Oct 07, 2017 9:33 pm
TD2626 wrote:
Sat Oct 07, 2017 9:16 pm
Some funds distribute capital gains and you have to pay taxes on those too. Selecting funds that trade infrequently or using Vanguard funds that funnel gains to in-kind etf redemptions can limit distributions. However, broad index funds (such as those at Fidelity) can distribute capital gains.

I agree that there is little short-term difference between a reinvested dividend and a share buyback. Over the long run, though, people invest in companies with an expectation of a return. I realize growth companies can grow and you get returns from rising share prices. But investors are assuming the company will eventually stop growing and start paying out, and isn't valuation predicated on that? If a company was committed to never paying a dividend untill bankruptcy, would it be worth it to own the stock? Or am I mistaken?
Look at Berkshire Hathaway - they are committed to never returning cash to shareholders via dividends - has it been worth it to own the stock and do you think it will continue to be?

Real valuation is not predicated on returning cash via actual 'dividend payments' - there are other ways to return value to shareholders.
How exactly would this work? If a company never pays a dividend, and goes bankrupt after decades of buybacks, aren't the only people who earned money those who sold to "greater fools"?
If a company goes bankrupt the only people who will have received something from their investment are people who withdrew their earnings from the investment along the way - whether that withdrawal was via dividend distributions or share sales is irrelevant. Someone who reinvested dividends is in the same position as someone who didn't sell their shares in a share repurchase (or other transaction).
I know it is worth something to own a fraction of an entity that has a lot of cash sitting around - but if that cash is only yours in theory, and will never be distributed in practice, what does that ownership amount to?
It amounts to a fractional ownership of the cash, even though that ownership doesn't include ultimate control. We can place a value on that ownership based on our expectations of what those who do control it will do (and earn) with that cash. That those expectations may not be realized doesn't invalidate the value today - if it did we wouldn't be investing in equities at all as even future dividend payments are predicated on our expectations of what those who control the asset will be able to do with it. This is of course why equity investments are risky.
I know Berkshire's total return history, and it's of course impressive - but aren't investors just valuing things based on the possibility that a distribution might be made in the future?
I hope not, they have been pretty clear about that so anyone basing their valuation on that possibility seems to be divorced from reality (I suppose it is possible that Buffet and Munger's successor will have a different perspective on that but I wouldn't place a bet on it).
Are there any good articles or research papers that you would recommend for learning more about the mechanics of how things work?
I wish I did, I don't know how you like to learn but the chapter in any Intro to Corporate Finance textbook that covers capital structure and dividend policy in particular should give it to you. If you want to dive into the research I think the best place to start is still with Modigliani and Miller's Dividend Policy, Growth, and the Valuation of Shares.

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Re: Dividends vs. Capital Gains for Spending Needs?

Post by TD2626 » Sat Oct 07, 2017 10:08 pm

triceratop wrote:
Sat Oct 07, 2017 4:14 pm
snarlyjack wrote:
Sat Oct 07, 2017 2:02 pm
KlangFool,

I can give you (some) of my reasons for liking dividends.

1). Since both of are parents are gone (I' am on my own &
can't borrow money from them in a emergency). In a emergency
I can use my credit card & pay if off with the next dividend payment.
(Financial Security).

2). Compounding, the 8th wonder of the world. When I reinvest
my dividend I get more shares. Since dividend payments are based on
the number of shares I have my dividends keep growing by the number
of shares that I have. So the fund is compounding out faster.

3). The "Big One" I don't need to sell off a portion of the fund &
I' am not stuck with the 4% Trinity Studies. However, I also have
the option to liquidate shares at anytime (just like everyone else).
It gives me more options. And since in my case they are tax free
why not use the options to my advantage.

4). Once my dividends are greater than my expenses I' am essentially free.
It gives me greater options. I' am not always checking my account values
I follow the trend line of the dividend payments. I' am much calmer &
less stressed about the stock market. I could care less what the
"talking heads on t.v. say". My life is serene...
1) the same applies by selling tax-efficient equities held long-term and transferring out the funds after settlement (2 days).
I agree, but using equities as an emergency fund (dividends or not) is very risky. Also, using a line of credit as an emergency fund is risky in my opinion as it is costly and can be withdrawn at any time. Living off a stream of dividends (or capital gains from sales) that cover some expenses (such that the emergency fund would be less needed) may make it rational to have a smaller emergency fund than if one was living solely off a job that could be suddenly lost.

2) This is false. Completely false. Compounding works on the dollars that you have. Your account value varies by a percentage of total value every day. Nothing more, nothing less. The only investing is total return investing. I agree with Triceratop. You can compound returns due to capital gains just as much as you can compound reinvested dividends.

3) You don't seem to get that by spending dividends you are withdrawing from the portfolio. Please re-read that sentence. Since you are withdrawing from the portfolio, you are absolutely subject to the 4% Trinity studies, or any other study on safe withdrawal rates. Also, your dividends are not tax free. As I've stated to you in past posts, your state tax on dividends is 6.5%. This is not an issue if you need to spend the dividends anyway, but if you're reinvesting the dividends it hurts you. I agree with Triceratop here. I especially agree with the phrase "by spending dividends you are withdrawing from the portfolio". Total return is what matters in the end, not where it came from. And dividend investing does have a tax drag in taxable - and it can be significant. I think this tax drag should be calculated in order to consider whether the tax drag outweighs any proposed or perceived benefits of dividend investing.

4) The same is true for tax-efficient stock index funds. You simply sell shares. By the way, dividends can absolutely be cut so it isn't as if you're immune to the stock market behavior. However it will take you less time to reach financial independence if you do not pursue a dividend strategy.
I disagree with the phrasing "You simply sell shares". In some situations, sales can be difficult, time consuming, expensive hassles involving SpecID with accounts that have hundreds of share lots. At a minimum it requires more work than simply cashing the dividend check. Someone who lives off of dividends saves this time and hassle, and the time savings could add up. But the investor should be knowledgeable about the tax drag that is being paid in exchange for the simplicity.

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