Dividend Based Strategies

Research on Safe Withdrawal Rates


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Dividend Based Strategies

Post by JWR1945 » Wed Jul 30, 2003 5:46 pm

Dividend Based Strategies

A year's safe withdrawal rate is heavily influenced by dividends. During the stressful, high valuation conditions for retirement start years 1959-1973, the safe withdrawal rates were just slightly above the dividend yield. Further investigations of other periods draw our attention to dividend amounts and how they behave.

Much of what I have learned is very familiar. Once again, my investigations tend to support what real retirees have done in real-life. This fits everything together in a coherent package. This is far from complete, but it has many of the more important points.

Touching Principal Lightly

Dividend amounts are reasonably well behaved. There have been some exceptions, primarily in the 1930s, and those exceptions are interesting in themselves. I have focused on real (i.e., adjusted for inflation) dividend amounts. There may be other stories, which I have not investigated yet, related to inflation and nominal dividends.

Consider what would happen if you owned a stock that had a constant price and a constant dividend yield. Assume that you started off with an initial balance of $1000 and assume that its dividend yield was 3%. You could withdraw $30 per year without ever touching principal. Now let us withdraw an additional $10 per year. That $10 is 1% of $1000. The total withdrawal would be $40 or 4% of the initial balance.

Let us continue to withdraw that $10 per year plus the full amount of the dividend. In the first year, the principal would be $1000. The dividend would be $30 and the total amount withdrawn would be $40. In the second year, the principal would have fallen to $990. The dividend amount would be 3% of $990 or $29.70. Taking another $10 out of the principal, your total withdrawal would be $39.70. By the tenth year, you balance would be down to $900 and the dividend amount would be $27 (3% of $900). Your total withdrawal would be $37.00 (or $10 plus the dividend amount).

Notice that if the price is steady and the dividend yield is steady, drawing down only 1% of your initial principal isn't too bad, even for a decade. You can tolerate minor fluctuations of all types. If you withdrew $40 each year instead of $10 plus the dividend, the results would be similar. The principal would have fallen more, but too much. Your portfolio would still be healthy.

That is pretty much what happened in the 1959-1973 time period. Prices fluctuated quite a bit but dividend amounts remained reasonably stable. The drawing down of principal was light enough not to hurt too much.

Stable Relationships

I have noted elsewhere that P/E10 has done remarkably well in relating valuations and yearly safe withdrawal rates. It makes sense to that dividends and the earnings part of P/E10 should be closely related. E10, the average of the previous ten years of earnings, is reasonably well behaved and earnings form the basis for dividends. Dividends tend to vary slowly since dividend cuts are punished severely in the stock market. Thus, it makes sense that dividends and yearly safe withdrawal rates should track each other closely. The discretionary nature of dividend payouts weakens this relationship. (There is an alternative interpretation: Dividends tell the truth and earnings, even when averaged over ten years, often contain a lot of fiction.)

Much of the time, a year's safe withdrawal rate is simply 20% to 60% higher than the dividend yield. Unfortunately, the scale factor is not very good. In many cases, the year's safe withdrawal rate is 1% or more than the dividend yield. The percentage increases when stock prices grow substantially. Sometimes, 1% is just a little high, especially when prices decline. What works best is to track dividends.

This rule of thumb works great...except when it fails. An abrupt fall in the dividend amount within two or three years causes the rule to fail. The rule applies, but you must use the later dividend and its yield. This shows us the importance of the quality of dividends.

Focus on Yields

The most stable relationship that I have found has been the ratio of a year's safe withdrawal rate to its dividend yield. Here is a summary. The list shows the year, dividend yield, the ratio of the year's safe withdrawal rate for a 50% stock allocation to the dividend yield and the ratio of the year's safe withdrawal rate for an 80% stock allocation to the dividend yield. (I actually used the rates at which the first failure occurred, which is 0.1% or 0.2% higher than a year's actual safe withdrawal rate.)

1921 7.11% 1.37 1.65
1922 6.35% 1.35 1.63
1923 5.74% 1.35 1.60
1924 6.02% 1.32 1.59
1925 5.27% 1.40 1.63

1926 4.82% 1.45 1.61
1927 5.19% 1.31 1.42
1928 4.43% 1.30 1.35
1929 3.46% 1.38 1.27
1930 4.47% 1.16 1.11

1931 6.07% 0.85 0.95
1932 9.55% 0.64 0.85
1933 6.98% 0.85 1.23
1934 4.19% 1.19 1.52
1935 4.85% 1.11 1.60

1936 3.50% 1.31 1.60
1937 4.17% 0.95 1.15
1938 7.02% 0.71 0.96
1939 4.10% 1.17 1.51
1940 5.06% 0.94 1.22

1941 6.41% 0.81 1.12
1942 7.87% 0.78 1.16
1943 5.90% 1.15 1.59
1944 5.19% 1.19 1.69
1945 4.77% 1.25 1.76

1946 3.70% 1.45 1.89
1947 4.69% 1.49 2.04
1948 5.69% 1.37 1.93
1949 6.18% 1.29 1.81
1950 6.84% 1.08 1.52

1951 6.98% 1.03 1.37
1952 5.86% 1.19 1.56
1953 5.40% 1.25 1.62
1954 5.73% 1.22 1.60
1955 4.34% 1.38 1.61

1956 3.78% 1.42 1.58
1957 3.82% 1.41 1.62
1958 4.33% 1.38 1.66
1959 3.15% 1.65 1.77
1960 3.21% 1.61 1.68

1961 3.26% 1.59 1.65
1962 2.93% 1.63 1.70
1963 3.28% 1.52 1.58
1964 3.00% 1.60 1.60
1965 2.92% 1.50 1.50

1966 2.93% 1.50 1.43
1967 3.41% 1.34 1.34
1968 3.08% 1.42 1.42
1969 3.01% 1.46 1.46
1970 3.50% 1.42 1.42

1971 3.35% 1.49 2.08
1972 2.98% 1.67 1.67
1973 2.67% 1.79 1.79
1974 3.53% 1.64 1.69
1975 4.99% 1.44 1.68

1976 3.80% 1.78 1.94
1977 3.97% 1.76 1.91
1978 5.22% 1.57 1.80
1979 5.12% 1.71 1.91
1980 5.18% 1.85 2.04

The behavior at an 80% stock allocation is amazingly good. You can spot a problem easily when the dividend yield drops dramatically within the next two or three years. The behavior is good at 50% as well.

Watching Principal

I made a cursory check of the behavior of start year 1929, which is unusual. I looked at the deficit between 4% of the initial price (i.e., index value) and the dividend amount as a percent of the initial price. This percentage was not at all bad for 1929, 1930, 1931 and 1932. The ratios we 0.53%, 0.08%, -0.18% and 0.17%. Then there were four years in which there was a heavy drain on the principal. The years 1933, 1934, 1935 and 1936 had deficits of 1.35%, 1.77%, 1.72% and 1.60%. The year 1933 was the bottom of the (real) index values (or stock prices) during the Great Depression. The (real) dividends dropped as well during those four years.

This kind of behavior continued, somewhat sporadically, with heavy drains on principal. In general, a drain of more than 1% of the initial principal in times of low prices is a danger signal.


Many real-life retirees have focused on dividends and for good reason. Dividends are more predictable than prices. If the income stream is steady enough and reliable enough, a retiree can tolerate a fair amount of price fluctuation.

The traditional emphasis on the quality of dividends is very well founded. If dividends or dividend yields fall within two or three years, the original safe withdrawal rate may have to be replaced with a smaller number.

The single most important thing is to avoid selling shares of stock at low prices. You do that by touching principal very lightly. Beware of pending danger if you must sell stocks at a hefty discount. Be concerned if you have to sell a dollar amount exceeding 1% of your initial principal. OTOH, if prices have increased, you are probably OK since you do not need to sell many shares.

Growth is another important factor. Adding asset classes is straightforward.

The attractiveness of designing a retirement strategy based on dividends is directly related to your ability to predict their behavior.

Have fun.

John R.

Joined:Mon Dec 02, 2002 12:56 am

Post by hocus » Thu Jul 31, 2003 1:16 am


You have been talking about the dividend issue for a long time. I don't possess a full understanding of the ways in which it intersects with the valuation issue and the ways in which it is independent of it. I would like to strengthen that understanding over time. So I much appreciate you putting this post up. This is an area I need to give more thought to over the coming months.

I'm sure that you did not miss these comments from the Crestmont post from yesterday:

Today, dividend yields and cash yields are significantly lower than the early part of the 20th century. High dividends and cash yields sustain a higher SWR. This was particularly true in the earlier parts of the 1900's and enables the hypothetical investor in SWR models to endure large market swings. Without the same level of current cash flow, the SWR models have significantly different results.


SWR seems to be about how much a retiree can withdraw from savings without running out of principal over a prescribed long term period. If stocks are destined for mediocre returns (maybe none over the next decade or so) and other sources of income imbedded in the historical data (i.e. dividends, interest, etc.) are substantially less today, how can retirees hope to fund relatively higher withdrawals (4%+)?

I hope we get to hash out the dividend questiion a bit in our discussion next Wednesday

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Post by JWR1945 » Thu Jul 31, 2003 5:13 am

Realize that my emphasis is to identify cause and effect relationships when I look at market history. We can then base our strategies based on an underlying theory instead of relying on numbers alone. We know what to look for and what to look out for.

In terms of making SWR calculations...not in terms of real-life, it makes no difference whether we identify dividends separately or whether we form an index with all dividends reinvested. The models do not distinguish between the two.

In the first case, the models show retirees living off of dividends with an occasional (and usually very light) sale of shares. In the second case, the models would show retirees living solely from sales (since they would not have direct access to dividends).

It turns out that a strategy based on the first approach (i.e., live off of dividends and maintain most of your principal) works very well in times of high valuations. It is something that you can monitor easily. You make sure not to sell down too much of your principal. It has built into it the prospects of mediocre returns (maybe none over the next decade or so).

In times of normal valuations, the same strategy does not work as well. Prices will rise and you can sell some shares of stock safely.

These are some very fine grain distinctions and I expect to learn a lot from Crestmont's research articles. I think that we are on the same page.

There is a fine grain distinction between what is and what has to be. If you keep that thought in mind, I think that you will be able to discern the subtleties.

Have fun.

John R.

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Post by FMO » Thu Jul 31, 2003 11:16 am

Imagine an investment which pays a dividend ranging from 6-12%, which has a long history of both the dividend and the market value appreciating at a rate equivalent to, or in excess of the general inflation rate. Imagine further that the income is partially tax-sheltered and that upon sale, the investment can be traded for a new investment with no tax whatsoever on the gains. Would that be a good thing for retirees?

"The mark of a successful man is spending an entire day on the bank of a river without feeling guilty about it."

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Post by JWR1945 » Thu Jul 31, 2003 1:03 pm

I suspect that FMO's mystery investment has limited liquidity so that the retiree is likely to hold on instead of panicking and selling at a heavy discount.

That psychological factor is an important plus.

Have fun.

John R.

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