6% for Early Retirement

Here are three ways to reach a 6% continuing withdrawal rate. They are suitable for your early retirement planning.

A Dividend Blend

Combine an investment with a high initial yield with another with a good yield but a fast growing dividend. Take excess funds from the high yielding investment to make up any shortfall in the middle years. Rely on the fast growing dividend to supply income in the later years.

The upside potential using one realistic set of numbers is 6.55% plus inflation.

Taken At Face Value: Upside

Another winning combination might be one of today’s preferred offerings at 8.0% interest and zero growth along with a 3.5% yielding portfolio that grows its payouts at 8% per year. Allocate 70% initially into the high yielding preferred shares and 30% into the dividend growing portfolio. This reaches a 6.0% continuing withdrawal rate if you are able to equal 1.4% TIPS in your cash management account.

A Delayed Purchase

Once again, I use high yielding preferred shares to help cover the early years.

BAC preferred series H has a yield of 8.2% and date to call in five years. I believe that this issue will be called. If so, it offers a very attractive beginning to a delayed purchase approach.

With a delayed purchase, you invest in a high yielding instrument to cover the first few years. After stock prices in general fall dramatically, you purchase high dividend stocks from quality companies. Judging from history and demographics, we can expect price multiples to fall by a factor of two within 5 to 10 years. Instead of getting 4% to 5% from high quality companies, we should be able to get 8% to 10%.

The key is not to take too severe a beating when redeeming the initial investment. With the BAC preferred shares, we are likely to do very well.

The likely outcome is a continuing withdrawal rate of 6% of the original balance (plus adjustments to match inflation).

Back of the Envelope 6%

Income Investing

With care, it is possible to select companies that have high payouts that can provide an income stream of 6% (plus inflation). These are income investments such as Master Limited Partnerships MLP (especially pipelines), equity REITS, high yield bond funds and special situations such as tankers (which have dividends that fluctuate greatly). Due diligence is especially important.

I do not feel qualified to address the details myself. Instead, I refer you to the Morningstar Income and Dividend Investing discussion board.

Morningstar

Downside Risk

The downside risk of S&P500 dividend amount since 1950 was 25% to 75% of the original dividend amount. The dividends eventually recovered and grew. Consider a drop to 75% of the indicated withdrawal rate as the worst case downside risk associated with these strategies. This works out to a temporary drop to 4.5% of your original investment (plus inflation).

A more typical downside risk would be 10% from a 6% withdrawal rate to 5.4% (plus inflation).

A prudent investor should consider limiting his withdrawals to 5.0% to 5.5% for about 5 years. This will build up his confidence. It will protect him, in part, from hidden flaws in my analysis. [I do not believe that there are flaws. But you should protect yourself with ANY analysis, regardless of its quality.]

Always take care to monitor your investments. Build spreadsheets, if needed.

Have fun.

John Walter Russell
June 4, 2008