Why It Works

Smoothing the Income Stream increases today’s Safe Withdrawal Rate to 5%, well above the 4% that is claimed traditionally. We can do even better. It doesn’t stop there.

This is why it works.

Traditional Strategies

Traditional strategies are liquidation strategies. They include the sale of stock to generate income. A bad sequence of returns in the early years leads to failure. The failure mechanism is selling too many shares when prices are low. They are vulnerable to the effect of price fluctuations.

Dividend Strategies

With dividend strategies, we live off the income produced by dividends. We do not sell any shares. We exploit the difference in the statistical probabilities of dividends as opposed to prices. Price fluctuations vary wildly. Dividend income is steady. Retirees need steady income.

Smoothing the Income Stream

A problem with dividends is that they do not match inflation. Typically, they start low and rise faster than inflation. In some instances, often with Master Limited Partnerships, they start high but do not necessarily grow as fast as inflation.

By having a TIPS (or other cash equivalent) account on the side, we can smooth the income stream.

Because dividends are predictable, at least in contrast to price fluctuations, smoothing the income stream allows us to lift the Safe Withdrawal Rate to 5% if we start with one of today’s higher yielding investments. This lasts at least 45 years. If we add a suitable investment with a lower initial dividend yield but with a fast dividend growth rate, we can boost the Safe Withdrawal Rate above 5.5%. It lasts indefinitely.

We can do even better if we incorporate The Delayed Purchase Concept.

The Delayed Purchase Concept

Conclusion

Smoothing the income stream lifts the Safe Withdrawal Rate for two reasons: dividend income is steady and we can select securities appropriate for retirement.

Have fun.

John Walter Russell
February 27, 2007