Back of the Envelope: Dividend Blend

Not everyone is comfortable using a spreadsheet calculator. Here is how to calculate a withdrawal rate for a dividend blend portfolio by hand. It is not exact. It comes close.

The Dividend Blend

The dividend blend consists of a high yielding investment along with a high growth investment. Growth, in this case, refers to growing the dividend amount. I use TIPS in a side account to manage cash flows. I take excessive cash generated by the high yield investment to fill in a deficit from the high growth investment in the early years. Eventually, the faster growing investment supplies most of the income.

I describe the two investments by their initial dividend yields, dividend growth rates (nominal) and allocations. The sum of the allocations equals the investment portfolio total balance, initially.

I never sell any shares. I assume a fixed inflation rate, usually 3%.

Critical Approximation

I set the initial TIPS allocation to zero.

This does not give the maximum withdrawal rate. But judging from several conditions that I looked at using the Automatic Allocator, it comes close.

Starting with zero TIPS is a reasonable allocation. It is not always the best allocation.

Hand Calculations

Multiply the investment portfolio total balance by the allocations and the initial dividend yields.

For N = 0, 10, 20 and 30, calculate:

withdrawal rate for year N = High Yield Investment income in year N + High Growth Investment income in year N = (High Yield Investment initial allocation)*(High Yield Investment scale factor) + (High Growth Investment initial allocation)*(High Growth Investment scale factor).

The scale factors are [(1+nominal dividend growth rate)/(1+inflation)]^N. Since the dividend growth rates differ, the High Yield Investment and the High Growth Investment will have different scale factors.

The lowest of these withdrawal rates will be close to optimal for its allocation.

Notice that you only have to calculate the scale factors once.

Look at a variety of allocations. Select the one that makes sense.

Comparison

Using my Automatic Allocator, I found that the best allocation was (close to) 5.7% when optimized fully. Using this back of the envelope calculation, the withdrawal rate was 5.5%.

Have fun.

John Walter Russell
June 10, 2007