6 Six Reasons Why Retiring on Dividends Might Work For You
1. You Want to Leave a Significant Inheritance and Don´t Need the Maximum Retirement Income
2. You´re Not Worried About Portfolio Falls of 40-50% Providing The Income Continues
3. You Are Worried About Sequence of Return Risks
4. You Want Simplicity and Don´t Want to Worry About Safe Withdrawal Rates, Portfolio Rebalancing and Equity/Bond Allocations
- What is the safe withdrawal rate (SWR)?
- By how much can this be increased each year?
- What to do during market crashes?
- If the market performs well is it safe to increase my withdrawal rate?
- What bond allocation should I have to balance risk against return?
- From which asset class do I take my income and how should I rebalance?
Retiring on Dividends eliminates some tough decisions.
5. You Want Your Income Protected from the Sometimes Irrational Behavior of the Stock Market
6. You Believe The Research That Dividend Paying Stocks Out-Perform Non-Payers
“Stocks that pay dividends have historically outperformed non-dividend-paying stocks over the long term. Not only are total returns driven by dividend growth over the long term, but dividend-payout policies may also help drive smarter capital-allocation decisions by management.”
However there is a large caveat! The best performers are those that have a high dividend yield combined with a low payout ratio – the dividend is well covered from earnings.
So to summarise why a Retiring on Dividends strategy may work for you:-
- Income not directly linked to market ups and downs
- Easy to implement compared to income drawdown
- Evidence that some dividend stocks outperform non-payers
- Probability of leaving a significant inheritance
6 Reasons Why Retiring on Dividends May NOT Work For You
1. Retiring on Dividends Results in a Lower Income
2. Dividend Portfolios are More Volatile and Higher Risk
A 100% equity dividend income portfolio will be significantly more volatile than a balanced equity/bond portfolio. The table below from Vanguard USA shows the returns and volatility of bond/equity portfolios from1926-2018. A 100% equity portfolio suffered a worst-case annual decline of 43% and a 40% equity portfolio a fall of 18%.
3. Dividend Portfolios Aren´t Diversified
4. Passive Dividend Income Funds Underperform Active Funds
5. Dividend Income is Variable
There can be a significant variation in dividend income, in particular from passive funds and ETFs. The graph below showing annual dividends from the SDY dividend ETF illustrates this well.
There are active investment vehicles such as Investment Trusts that by retaining earnings during the good years can smooth out their payments. My Investment Trust Retirement Income Portfolio produced less volatile income but these are actively managed funds with higher management fees than most passive funds and of course, there is no magic in retaining some earnings for the future – most of us have some kind of ¨rainy day¨fund.
6. Dividend Income is Less Tax Efficient
- Portfolio Diversification
- Lower costs
- Higher income
- The ability to personalise the risk/return portfolio profile
- Stability of Income
- Extensive data to allow portfolio optimization
- Potentially tax-advantageous (CGT allowance)