Is a prospective retiree better off buying dividend etfs or capitalisation etfs?

[john_1122]

I am reading "The elements of investing" (as recommended by someone in geoexpat, thank you for that), they mention that you are better off buying broad etfs that capitalise rather than distribute their dividends, since this is more capital efficient. One such ETF is SPY (though they mention others). These ETFs are very broad and most companies they include pay low dividends. SPY has a yield of 1.25% after taxes.

Instead of SPY, I have been buying ETFs that focus on high yielding stocks (EUHD, ISPA, GLDV, VUKE, HDLV). I try to buy UCITS so I "only" pay 15% taxes. Their yield is about 4.5% (after taxes), and their performance is similar over the last 10 years. Of course SPY performed better.

The reason why I have been doing high-yielding ETFs is because I would like to live with the dividends, and not having to sell the stocks. I think this is a wiser approach in a falling market, but I would like to check with you if my approach is wise or not. Let me give you a numerical example of my thinking. Let me assume that the stock price drops by 50% and remains at the lower prices for 5 years before rebounding by 100% (i.e. reaching previous high prices). I need $45,000 a year to live. These are the two approaches, 1. with SPY (which now pays a 1.25% dividend), and 2. with high-yield stock ETFs.

1. I buy $1 M. of SPY, after the stock market drops by 50%, I have $500,000 left. I need $45,000 a year. I receive $12,500 as dividend from SPY, and for the rest I sell SPY (45,000-12,500 a year, for 5 years = $162,500). After 5 years I am left with (500,000 - 162,500 =) $ 337,500. At year 5 SPY doubles, so at the end of year 5 I have (337,500 x 2 =) $ 675,000.

2. Approach with high yielding ETFs: I buy $ 1 M. of high yielding ETFs. Their price drops by 50%, but I keep getting the dividend of 45,000 (assuming the companies keep paying the dividend!!), so I don't need to sell them. After 5 years I have $ 500,000. It only needs to go up by 35% for me to have the same $ 675,000 which would need a 100% rise with SPY.

In a rising market, clearly SPY would be the favourite stock, since it grew by 200% since 2010, and ISPA (for example) only by 36%. However, in a dropping market high-yielding ETFs seem to be a better alternative? Of course high-yielding stocks may cut their dividends, but many of them are dividend aristocrats, so they have an interest in trying hard to keep paying them (at least most of them).

What are your thoughts?

[shri]

Their price drops by 50%, but I keep getting the dividend of 45,000 (assuming the companies keep paying the dividend!!), so I don't need to sell them.

DO NOT make that assumption - do your calculations based on %age return and not absolute cash.

Just take a look at the absolute (i.e. cash distribution per share) over a several month period to see why I said that and then.... report back, esp when they declare Q2 distributions.

[MandM!]

What’s your personal appetite? A friend thought I’m a pro at stocks and kept asking me for advice. I said don’t buy. He bought HSBC at $60 and sold at $37. If you buy you have to be able to keep it and ride out the times. If you are anxious and look daily it’s difficult.

Diversify, buy some properties, some stocks, some time deposits and a good deal of cash for when shit hits the fan. I loaded up on stocks end March so that was good. But still I realize this is a risk investment and only invest what I don’t need.

When someone is younger they have less cash. When you are older you have enough to split it up to different asset classes. So my advice is for young people to focus on saving cash and older people focus on diversification.

[traineeinvestor]

I haven't read the book (in spite of the stellar recommendations being made on this forum) but will offer some random observations:

1. funds which do not make distributions may avoid the double tax problem – tax has already been paid on the underlying earnings and will be paid again (either as non-resident withholding tax or income tax depending on where the investor lives and where the fund is domiciled). YMMV depending on which jurisdictions you are looking at

2. if you intend to re-invest anyway, there will be transaction costs on the reinvestment (possibly offset if there is a discount offered on reinvestment)

Separately from this, the problem you have described is known as "sequence of return risk" which is faced by all retirees who need to draw down assets to fund their retirement. The problem is that far too many financial plans are based on average returns on investments – but do not account for the fact that it will be very unlikely that an investment will return the average in any single year.

Some years it will do better and some years worse. If you get below average years at the beginning of your retirement period your fund will run down more quickly than planned and above average returns later on will not recover the shortfall because they will be earned on a reduced pot of money. The reverse is also true – if you get above average returns at the beginning you will end up with a bigger nest egg than originally projected.

Sam Savage's excellent book "The Flaw of Averages" explains this (and other problems with using averages) in some detail. There's an article by the author here:

https://hbr.org/2002/11/the-flaw-of-averages

You can also use FIRECalc on earlyretirement.org to do the financial modelling for you.

https://firecalc.com

[traineeinvestor]

What’s your personal appetite? A friend thought I’m a pro at stocks and kept asking me for advice. I said don’t buy. He bought HSBC at $60 and sold at $37. If you buy you have to be able to keep it and ride out the times. If you are anxious and look daily it’s difficult.

Diversify, buy some properties, some stocks, some time deposits and a good deal of cash for when shit hits the fan. I loaded up on stocks end March so that was good. But still I realize this is a risk investment and only invest what I don’t need.

When someone is younger they have less cash. When you are older you have enough to split it up to different asset classes. So my advice is for young people to focus on saving cash and older people focus on diversification.

+1

There will be times when the financial universe confuses your retirement plan with toilet paper – diversification + cash on hand + manageable debt allows retired people to sleep at night.

[Kowloon72]

What’s your personal appetite? A friend thought I’m a pro at stocks and kept asking me for advice. I said don’t buy. He bought HSBC at $60 and sold at $37. If you buy you have to be able to keep it and ride out the times. If you are anxious and look daily it’s difficult.

Diversify, buy some properties, some stocks, some time deposits and a good deal of cash for when shit hits the fan. I loaded up on stocks end March so that was good. But still I realize this is a risk investment and only invest what I don’t need.

When someone is younger they have less cash. When you are older you have enough to split it up to different asset classes. So my advice is for young people to focus on saving cash and older people focus on diversification.

That in bold is the worst investment advice I've ever read.

[MandM!]

That in bold is the worst investment advice I've ever read.

I’m confident I have more money than you. So I’d rather learn from someone who has vs someone who doesn’t have.

[john_1122]

Thank you all. My math may be off, but the central point is:

If the share market is dropping, is it better to
1) buy ETFs with a high dividend, and try to live off the dividend, thus keeping all your stocks, or
2) buy ETFs that don't distribute a dividend, where you are forced to gradually sell the stocks, at a lower and dropping price.

[MandM!]

Thank you all. My math may be off, but the central point is:

If the share market is dropping, is it better to
1) buy ETFs with a high dividend, and try to live off the dividend, thus keeping all your stocks, or
2) buy ETFs that don't distribute a dividend, where you are forced to gradually sell the stocks, at a lower and dropping price.

If the market is dropping there is exposure to potential dividend cuts. Focus on profitable companies with future rebound potential.

[shri]

I’m confident I have more money than you. So I’d rather learn from someone who has vs someone who doesn’t have.

In general - advice given by people and institutions that have far far more money than the combined networth of the whole f'ing forum is - Younger people are better equipped to handle risk when they're earning and should opt to grow their net worth and take risks as they have a longer time window to work with.

By "in general" I mean excluding some excruciating personal circumstances and biases.