Dividend Sound Bite

Here is how you go about withdrawing 4.8% of your portfolio’s original balance (plus inflation), safely and perpetually, starting from today’s stock market.

Detailed Instructions

You start with 2% TIPS (Treasury Inflation Protected Securities). They allow you to withdraw 4.00% each year (plus inflation) for 35 years, 4.46% (plus inflation) for 30 years or 5.12% (plus inflation) for 25 years before running out of money.

You buy high-dividend stocks from quality companies when the S&P500 dividend yield rises above 4.0%. This should occur within a decade. Based on DVY’s yield relative to the S&P500, you should be able to get a secure dividend yield of 6.9% or more. (DVY is an exchange-traded fund. It invests in high-dividend, high quality companies.)

If you withdraw 4.8% of your original balance (plus inflation) from a 2% TIPS portfolio, your principal will still be 69.3% of your original balance (plus inflation). If you buy stocks yielding 6.9% using 69.3% of your original balance (plus inflation), the stock dividends are (6.9%*0.693=) 4.8% of your original balance (plus inflation).

Likely Outcomes

What is better, once you have converted to stocks, your dividends are likely to grow. The downside risk is a 10% decline (in the 4-year moving average) at year 4 with full recovery by year 8. Most likely, your dividend payments will have grown by 40% to 50% within another 8 to 12 years, possibly by as much as 100% to 150%.

Worst Case

The worst case would be that dividend yields never return to their historical range. If you were stuck with TIPS, never being able to buy suitable stocks, your 4.8% (plus inflation) withdrawal rate would last 27+ years.

Have fun.

John Walter Russell
January 18, 2006