Using the TIPS Income Stream Allocator B

I have built a spreadsheet to help with income portfolios. This tells you how to use it.

The TIPS Income Stream Allocator B

The TIPS Income Stream Allocator B is a simple spreadsheet. You identify two investments by entering their initial yields and growth rates (making no adjustments for inflation). The third investment is TIPS. You identify its real interest rate. You also specify the rate of inflation.

NOTE: There is another version, the CD Income Stream Allocator A. Its CDs have a constant (nominal) interest rate.

The income streams from Stock A and Investment B continue to grow at a constant rate. I do not simulate their price behavior. I do not allow purchases or sales.

This eliminates the danger inherent in a more conventional approach that includes selling shares for extra income. You never sell shares when prices are temporarily depressed. In fact, you never sell shares, period.

If you withdraw only a part of the income stream from Stock A or Investment B, I put the excess into the TIPS account.

I have automatically limited your withdrawals from Stock A and Investment B to be from zero to the total amount of income produced, but never anything more. If you wish to treat Stock A and Investment B equally, enter a withdrawal amount far higher than the income produced. Any surplus beyond the total amount withdrawn gets added to the TIPS account.

Entering Numbers

There are three inputs: "Nominal A Withdrawal Attempt" for Stock A, "Nominal B Withdrawal Attempt" for Investment B and "TIPS Nominal Withdrawal."

There are no constraints on the TIPS Nominal Withdrawal.

A negative TIPS withdrawal is a deposit into the TIPS account.

The spreadsheet allows the TIPS portfolio balance to become negative. A negative TIPS balance indicates that something has to be changed or that the perpetual income stream has failed at that point.

As a practical matter, you vary your TIPS withdrawals while looking at TIPS balances. You optimize your withdrawal approach by making sure that Stock A and Investment B have grown enough to fill any deficit in the later years.

Once you have found a satisfactory sequence of TIPS withdrawals, you can go back and change the Stock A and Investment B allocations to find what works best. The TIPS withdrawals will be close to optimal. As a final step, you can revisit your TIPS withdrawals to get the best possible result.

I use the "Real Withdrawal Amount" to judge my progress. Most of the time, I try to maintain a constant amount of buying power throughout the first 40 years. I try to keep the "Real Withdrawal Amount" nearly constant while maintaining a positive TIPS balance.

Strategies

One strategy is to maintain a constant income stream after adjusting for inflation. The objective is to maximize this income stream using available investments.

An alternative approach might be to maintain a higher income stream for the first fifteen or twenty years with the intention of selling some shares much later, most likely with a capital gain.

I prefer an approach that looks for a buying opportunity starting within 5 years with a bottom before 2020. To do this, I overweight the TIPS holdings in the early years, gradually increasing stock holdings as bargains become available. Identifying bargains is straightforward. They are high quality companies with good prospects and high dividend yields.

Judging from the S&P500, we can expect market dividend yields to double as the market returns to normal and to quadruple at the next bottom. It makes sense to add stocks gradually. The exact bottom and its exact timing are unknown. The approximate magnitude and approximate timing are known and they are actionable.

Additional Information

Most of the time, the sum of the dividend yield and the dividend growth rate of the S&P500 has been 9% to 10% (nominal). This is close to the long-term annualized, nominal, total return. Today’s stock prices are twice normal with an S&P500 dividend yield just below 2%.

The S&P500 dividend nominal growth rate has been remarkably stable. It has been close to 5% per year (nominal).

You can find out about Single Payment Immediate Annuities with constant dollar payouts at

Immediate Annuities Site

(without any options with inflation adjustments) and through links starting from Vanguard’s Retirement section (with options that include inflation adjustments) at

Vanguard Retirement Section

The book “Mergent’s Dividend Achievers” lists companies with a long history of annual dividend increases. Mergent has licensed dividend growth listings to several Exchange Traded Fund companies. This may help with dividend growth estimates.

Mergent’s 2007 Press Release

Have fun.

John Walter Russell
January 30, 2007