A Ten Percent Withdrawal Rate

The Something Simple portfolio has fallen in price. If you invest in it today, you can withdraw ten percent of your original balance each year. The risk is reasonable.

Today’s Yields

According to Yahoo Finance, dividend oriented Exchange Traded index Fund DVY now yields 8.18%. Preferred stock Exchange Traded index Fund PFF now yields 14.27%. [These are distribution yields.]

I assume that DVY has a 5.5% per year growth rate, which is equal to that of the S&P500 (long term). I assume that PFF has a zero percent per year growth rate, which may be overly optimistic.

I also looked at the Vanguard High-Yield Corporate (VWEHX) bond fund. It yields 9.86%.

Interesting Combinations

A straightforward application of the Simplified Automatic Allocator shows that a 50%-50% allocation of DVY and PFF supports a withdrawal rate of 10.6% plus 3% per year to handle inflation.

The same combination supports a withdrawal rate of 9.2% with a 4% per year adjustment to handle inflation.

If we assume that PFF reduces its payout by 5% per year, you can still withdraw 8.8% plus 3% per year to handle inflation.

If we invest in DVY and VWEHX and assume no decline in the VWEHX payout, you would be able to withdraw 8.8% plus 3% per year as well.

If we invest in DVY and VWEHX and assume a 2% per year reduction in the VWEHX payout, you would be able to withdraw 8.4% plus 3% per year inflation.

I also considered a safer allocation. I set the DVY allocation at 80%. I set the PFF allocation at 20%. I assumed that PFF loses 5% per year. This combination supports a withdrawal rate of 9.3% plus 3% per year increases to handle inflation. It also supports a withdrawal rate of 8.8% with 4% per year increases to handle inflation.

Risk Assessment

DVY is now well diversified. It is 20% in financial services and 20% in utilities. I consider this a safe holding, looking forward.

PFF is 80% in financial services. Its holdings are diversified within this sector. This is NOT a diversified risk. However, the Government seems intent on protecting bond holders and preferred stock holders at the expense of common stock holders. I believe that regulators allow such bonds and preferred shares to be used for meeting minimal capitalization requirements for lending. If so, the Government is simply protecting itself.

VWEHX is among the safest of the junk bond funds. It has a long history with a slow decline in its payout.

Remarks

Now is a good time to start investing in the Something Simple portfolio. More conservative investors will select the 80% DVY and 20% PFF allocation and start out with a 9% withdrawal rate, followed by 3% per year increases to handle inflation during the first few years. They might later increase withdrawals if inflation gets out of hand.

A conservative investor with $300000 today would have a continuing income stream of $27000.

An investor with $300000 who is willing to accept more risk might try the 50%-50% allocation and withdraw up to $31800 per year.

My own recommendation is to delay buying for a few more months. I believe that the opportunities will get even better. [I have no guarantee. This is only my guess.] My preference is to ease into stock holdings gradually over the next few years.

Have fun.

John Walter Russell
April 6, 2009

Second Thoughts

Michael sent me a Letter to the Editor pointing out the differences in yields reported from different sites. Upon close inspection, the 8.18% yield that I used for DVY is in question. If we were to use 5.31% instead, the withdrawal rate would be 8.6% plus 3% per year for inflation.

April 8, 2009

March 23, 2009 Letters to the Editor