Early Retirement Portfolio Income, 2017 Q1 Update

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While I understand the arguments for a “total return” approach, I also appreciate the behavioral reasons why living off income while keeping your ownership stake is desirable. The analogy I fall back on is owning an investment property that produces rental income. If you are reliably getting rent checks that increase with inflation, you can sit back calmly and let the market value fluctuate. The problem is that buy only things with the highest yields only increases the chance that those yields will drop. Therefore, I am trying to reach some sort of balance between the two approaches.

A quick and dirty way to see how much income (dividends and interest) your portfolio is generating is to take the “TTM Yield” or “12 Mo. Yield” from Morningstar (linked below). Trailing 12 Month Yield is the sum of a fund’s total trailing 12-month interest and dividend payments divided by the last month’s ending share price (NAV) plus any capital gains distributed over the same period. SEC yield is another alternative, but I like TTM because it is based on actual distributions (SEC vs. TTM yield article).

Below is a close approximation of my most recent portfolio update. I have changed my asset allocation slightly to 65% stocks and 35% bonds because I believe that will be my permanent allocation upon early retirement.

Asset Class / Fund % of Portfolio Trailing 12-Month Yield (Taken 4/19/17) Yield Contribution
US Total Stock
Vanguard Total Stock Market Fund (VTI, VTSAX)
25% 1.88% 0.47%
US Small Value
Vanguard Small-Cap Value ETF (VBR)
5% 1.83% 0.09%
International Total Stock
Vanguard Total International Stock Market Fund (VXUS, VTIAX)
25% 2.75% 0.69%
Emerging Markets
Vanguard Emerging Markets ETF (VWO)
5% 2.31% 0.12%
US Real Estate
Vanguard REIT Index Fund (VNQ, VGSLX)
6% 4.42% 0.27%
Intermediate-Term High Quality Bonds
Vanguard Intermediate-Term Tax-Exempt Fund (VWIUX)
17% 2.87% 0.49%
Inflation-Linked Treasury Bonds
Vanguard Inflation-Protected Securities Fund (VAIPX)
17% 2.20% 0.37%
Totals 100% 2.50%

 

The total weighted 12-month yield on this portfolio has historically varied between 2% and 2.5%. This time, it was on the higher end of 2.50% mostly because inflation has picked up and thus the TIPS fund started to yield more. If I had a $1,000,000 portfolio balance today, a 2.5% yield means that it would have generated $25,000 in interest and dividends over the last 12 months. (The muni bond interest in my portfolio is exempt from federal income taxes.)

For comparison, the Vanguard LifeStrategy Moderate Growth Fund (VSMGX) is a low-cost, passive 60/40 fund that has a trailing 12-month yield of 2.12%. The Vanguard Wellington Fund is a low-cost active 65/35 fund that has a trailing 12-month yield of 2.55%. Numbers taken 4/19/2017.

These income yield numbers are significantly lower than the 4% withdrawal rate often quoted for 65-year-old retirees with 30-year spending horizons, and is even lower than the 3% withdrawal rate that I usually use as a rough benchmark. If I use 3%, my theoretical income would cover my projected annual expenses. If I used the actual numbers above, I am close but still short. Most people won’t want to use this number because it is a very small number. However, I like it for the following reasons:

  • Tracking dividends and interest income is less stressful than tracking market price movements.
  • Dividend yields adjust roughly for stock market valuations (if prices are high, dividend yield is probably down).
  • Bond yields adjust roughly for interest rates (low interest rates now, probably low bond returns in future).
  • With 2/3rds of my portfolio in stocks, I have confidence that over time the income will increase with inflation.

I will admit that planning on spending only 2% is most likely too conservative. Consider that if all your portfolio did was keep up with inflation each year (0% real returns), you could still spend 2% a year for 50 years. But as an aspiring early retiree with hopefully 40+ years ahead of me, I like having safe numbers given the volatility of stock returns and the associated sequence of returns risk.

Comments

  1. Jonathan,

    It is nice to see how your financial independence is progressing well. It looks like your dividend & interest income can cover 80% or so of your expenses, using a lower “withdrawal rate” than the one used by most investors today. I think you are probably in better shape than most early retirees too, since you will likely continue working in some enjoyable capacity for years after you can call yourself early retired.

    DGI

  2. Big John says:

    Another great feature of your approach is the better dividend growth. Starting with 2% yielding stocks will likely grow 4-5% a year. Starting with higher yielding stocks will see less growth. I suppose at some point your lower yielding portfolio might catch up with the higher yielding one. Well in the 40+ years you are looking at, it might happen.

    • Thanks, that is the plan. I am hoping that by spending the dividends from the 65% stocks and 100% of the bond interest, the overall dividend will still keep up with inflation (actually I am hoping that it will grow a bit faster).

  3. Ken in GA says:

    Jonathan;

    From your previous post sharing your current allocation, it appears to me that you steer clear of owning individual stocks. Have you ever considered buying any that have a history of being reliable dividend payers? We have a number of large caps like that in our portfolio — Coca Cola, J&J, Home Depot, and our regional electric utility. I did a calculation similar to yours recently and found that having positions like this seems to give a pretty good boost to our yield. Although the risks of owning individual issues vs. mutual funds is always something to take into account, I would think a few blue chip dividend paying stocks are a nice addition to a portfolio for income oriented investors. Have been a fan of your blog for several years now!

    • I am not against holding a basket of reliable dividend stocks. I have some individual holdings like KO and JNJ in my “fun portfolio” which is not included here. But they are a small fraction and I use them as learning tools. I also own BRK which acts like a mini basket of dividend stocks in an IRA since the internal dividends from the subsidiaries never get distributed until I decide to sell my Berkshire shares. If you keep your trading costs low, tax turnover low, and aren’t paying 1% to a money manager, I think you can end up just fine. The catch is that if you aren’t careful, you can get in trouble. You’re taking manager risk, and you are the manager.

      However, in general I don’t think there is a huge free lunch by owning high-yield dividend stocks. If you have something with high current yield, the dividend or price may not grow as fast. If you look at a well-respected, great-track-record, low-cost fund like Vanguard Dividend Growth, they pick promising dividend stocks but their yield is only 1.90%. Put it this way: If you have a basket of stocks yielding 3%, it’s not like it automatically will earn 1% more than a basket of stocks yielding 2%.

      Wellington Fund is a similar actively-managed example. Good management, loooong track record, low costs. They pick high dividend stocks and higher yielding bonds to squeeze out a bit more yield. But in terms of total return they really haven’t done a huge amount better than a index benchmark or Vanguard Balanced which is passive. Sometimes they’ll do a little better. Sometimes they’ll do a little worse. I still like them because I believe the downside is relatively limited with their low-cost conservative structure. If you’re going to take a risk on an active fund and can deal with the higher tax drag from dividends and capital gains due to turnover, I would pick Wellington.

  4. I think inflation will be rising over the next few years because the economy is starting to heat up and interest rates are going up. Thus (like you said), 2% is probably too conservative a target.

  5. Perhaps in a separate post, I would be interested in a discussion about how you’ve spread your assets across the different types of accounts: taxable, pre-tax, and post tax.

  6. Hi Jonathan,
    Curious what is the fina portfolio number you have in mind in terms of annual expenses?

    • I am purposely vague as to the absolute number, but if you assume $50,000 in annual expenses at a 3% withdrawal rate that is $1.67 million. This ignores other sources of retirement income including Social Security, pensions, annuities, etc.

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