Notes starting from June 20, 2008

Updated: July 12, 2008.

A Dividend Blend for Today

I examined a realistic dividend blend. It produces a continuing withdrawal rate of 6% of the original balance (plus inflation).

A Dividend Blend for Today

The Safe Withdrawal Rate Problem

Sad to say, many people have no understanding when it comes to the Safe Withdrawal Rate problem. I am not talking about calculation details. I am talking about the big picture.

The Safe Withdrawal Rate Problem

Dividend Strategies and Inflation

I routinely refer to the worst case cut in dividend income as being 25% (to 75% of its original buying power) based on the S&P500. This includes the effect of inflation. Nominal dividends (that is, without adjustments to match inflation) grew steadily throughout the 1950 to 2000 time period.

My caution includes the effect of hyperinflation. You need not be concerned about my choice of a 3% inflation rate based on recent history.

Portfolios Matter

With some portfolios, a withdrawal rate of 4% is not really safe. With others, a withdrawal rate of 5% or 6% is totally safe. Be careful. Understand the details.

Elements of Skill

Here are several elements of skill that you can adopt as your own. From December 2007:

Elements of Skill

From Why People Ignore Valuations

Over a very wide range of conditions, historically, the optimal fixed stock allocation was 80%. Only when we demanded the highest levels of safety or when TIPS were especially attractive have lower stock allocations made sense.

What is the best stock allocation? In the past, there was a single answer: 80% stocks. Most often, it was the right answer. Valuations had little effect.

Today, there are differences. Today’s valuations are outside of the traditional range. They are well above the traditional danger level, P/E10=20. Today’s TIPS are yielding 2.4%, much better than commercial paper has been historically.

What is the best stock allocation? Today, we have many answers. They depend upon the amount of safety that we demand. They depend upon the TIPS interest rate. They depend on the Terminal Value percentage. Most of all, they depend upon P/E10 (valuations).

Why Do People Ignore Valuations? In the past, it did not matter. It did not affect stock allocations. Today, it does.

May 30, 2006

Why People Ignore Valuations

Now that P/E10=23

Stocks are in bear territory. It seems that bargains abound. Should you buy now?

Now that P/E10=23

Why Use P/E10?

Professor Robert Shiller came up with P/E10 as his measure of valuation. It is spectacularly successful.

Why Use P/E10?

DVY Payouts

I use the Exchange Traded Fund DVY as a proxy for dividend stocks in general. The price of DVY has fallen as have many other equities. Its payout has continued to grow. This is in spite of dividend cuts among financials.

DVY's dividend amount has grown by 7.5% per year, which is not too shabby. This compares favorably with the S&P500 index. The S&P500 (nominal) dividend amount grows steadily at 5% per year.

DVY at Morningstar

Inflation Proofing Your Portfolio

I ran a sensitivity test. You can continually withdraw 5% of your original balance (plus inflation) today even if inflation climbs to 6%. If inflation stays at 3%, you can continually withdraw 6.5% (plus inflation).

Inflation Proofing Your Portfolio

The Wrong Lessons

I noticed this while browsing through the General Topics Archives. It is well worth reading.

The Wrong Lessons

Flaws in the Traditional Theory

This is another winner from the General Topics Archives.

Flaws in the Traditional Theory

Dividend References

Here are three books that will help you build dividend portfolios:

1) Mergent’s Dividend Achievers
2) The Single Best Investment by Lowell Miller and
3) The Dividend Growth Investment Strategy by Roxann Klugman.

All three are helpful even though they are oriented towards capital appreciation instead of income streams. All three contain very specific information. You can compare selections from the past with current results to get a feel for how accurately you can predict the future.

Take Roxann Klugman’s long term dividend growth projections with a grain of salt. It is very hard to predict dividend growth beyond just a few years.

With P/E10 Close to 20

Today, P/E10 is below 23. Stock prices have fallen sharply. What should we expect when P/E10 falls to 20?

With P/E10 Close to 20

Selling Shares

With dividend strategies, you never sell shares to generate income. But you do sell shares. You replace stocks when the dividend quality declines. You replace stocks on occasion to improve the quality of your holdings.

Five Great Choices

Today, we have five alternatives. They all leave the traditional approaches in the dust.

Five Great Choices

Market Behavior

I use Professor Shiller’s S&P500 data to estimate overall market trends. Figure 1.3 is very illuminating. It shows P/E10 versus time. It is clear that today’s valuations are still very high. The likely, long term direction of the market is to lower P/E10 multiples, possibly through price decreases, earnings growth, inflation or the combination of all three. We are in a long lasting (secular) bear market. We can expect multiples to drop considerably over the next 5 to 10 years.

For a more detailed description of market behavior, I recommend Ed Easterling’s Crestmont Research web site. For weekly updates on the market, I recommend John Hussman’s commentary.

Professor Shiller’s Web Site
Crestmont Research
Dr. John Hussman’s Web Site

If Only 4%

What if you are satisfied with only a 4% (plus inflation) withdrawal rate? You need not own any stocks.

If Only 4%

If Only 30 Years

What if 30 years is enough? You can reach a 4% Safe Withdrawal Rate easily without owning regular (common) stock.

If Only 30 Years

Today’s Market is Why

I like the Delayed Purchase approach and Rob Bennett likes Valuation Informed Indexing. Those holding onto large stock allocations feel the stress. Prices have fallen 20% and the outlook is not good. Sure, there may be a rally in the near future. There may be a sharp decline. I cannot discern the short term. But P/E10=22 today and P/E10 levels above 20 have always been dangerous.

P/E10=14 is typical.

If we look 5 to 10 years into the future, we can expect stock valuations to return to the typical range. This outcome is almost certain. This may be the result of falling prices, improved earnings, inflation or a combination. Most likely, prices will fall farther. The odds are about 50%-50% that P/E10 will fall below 10.

We can wait on the sidelines safely, taking advantage of TIPS or other fixed income investments. There is no need to panic. The payoff from waiting is huge.

Still, you may have a need to have some money in the market. What if stocks were to rally 30% over the next few months? It could happen. Would you load up on stocks at higher prices? At the worst possible time? A minimum allocation of 20% to 30% makes sense.

July 12, 2008

Notes starting from November 23, 2007

Notes Index starting from November 23, 2007

Notes Index

Notes Index

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