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A few weeks ago, fellow FIRE blogger and our good friend Jeremy from GoCurryCracker responded to a reader question about whether it makes sense to build a portfolio so that you could live off the dividend yield completely.
This is what he concluded:
The answer is simple: don’t live off just dividends.
His answer was based on looking at the relative performance of Vanguard’s High Dividend ETF compared to just the index over the period of his retirement. In the below graph, blue = the High Dividend ETF.
His conclusion: the index returned MORE during the same timeframe, so focusing on yield handicaps you. After all, if you get more yield, but less return overall, then that’s not a great deal is it?
This of course sent a bunch of emails into our inbox demanding to know our response, since we wrote a whole series about our plan to use dividends to mitigate against sequence-of-return risk, which we name the Yield Shield.
So I thought this would be a good opportunity to respond with a few slick-looking graphs of our own. But before we do, I want to take a moment to tell you all what I think of Jeremy.
This Jeremy guy…is one smart cookie, and he is absolutely right.
Total Return vs. Yield
Over the long term, a yield-centered portfolio will underperform the index.
Why?
Because whatever vehicle you use to invest to get yield, whether it’s dividend-heavy stocks like the ETF he showed in his chart, or preferred shares, or corporate bonds, the underlying companies issuing this securities will be similar: mature, blue-chip corporations with way too much cash that it doesn’t know what to do with, besides handing it back to their shareholders. These companies are the the Bank of Americas and the ReMax’s of the index.
And that’s great, but investing this way exclusively will ignore the young, faster-growing companies of the index. After all, while a mature car company like Ford is unlikely to grow 300% in a year, a smaller company like Tesla might, and that’s where the outperformance of a total-market index funds like VTI get their juice. Tesla, after all, doesn’t pay dividends.
And that’s why we actually don’t advocate chasing yield long-term. If you read our Yield Shield series carefully, you’ll notice that we actually advise using the Yield Shield portfolio in a very narrow, specific way.
And that’s at the beginning of your retirement to mitigate from of sequence-of-returns risk.
Sequence Of Returns Risk
So to recap: the whole FIRE movement is based off the 4% rule, whose full definition goes something like this:
A retiree can withdraw 4% of their starting portfolio, adjusting with inflation each year, and not run out of money with a 95% probability of success.
Great. 95% is great. But what about those 5% of people who don’t make it? Those people fell victim to bad timing.
Digging into the data, if a retiree were to invest your retirement portfolio in the stock market, and they were to experience a few good years of gains and then a loss due to a recession, they were OK. But if they happened to retire right before a bad bear market, they’d be forced to sell into a down market. And as a result, as the market recovered, the wouldn’t have been able to participate in the upside. These people would have run out of money in their retirement.
The sequence of returns becomes very important for these retirees, hence the name “Sequence Of Returns Risk”.
The Yield Shield portfolio’s job is to mitigate this risk.
By pivoting our portfolio into higher-yielding assets like Preferred Shares, Corporate Bonds, REITs, and Dividend Stocks, we raised our portfolio’s yield in the first few years of retirement from a paltry 2% to around 3.5%.
That’s 3.5% of $1 million, or $35,000, that we get paid regardless of whether our overall portfolio goes up, down, or sideways. That extra yield, combined with our Cash Cushion, made it so that we didn’t have to sell an assets when our portfolio was sitting at a loss. Because when you invest in the stock market, and it’s gone down, the WORST thing you can do is sell at a loss. You not only lock in your losses, but you have less units to carry you back up when the inevitable rebound occurs.
Charts or it didn’t Happen!
Now, all this is great, but how does the Yield Shield actually perform in a recession? Since we retired in 2015, we’ve had a few stock market downturns but not a full-blown recession. And definitely nothing like the 2008/2009 Great Financial Crisis. So how do we know that this Yield Shield stuff actually works, and it isn’t just a bunch of internet idiots patting themselves on the back?
Great question.
First of all, there’s a misconception out there that the Yield Shield portfolio is a magic bullet that just saves you from market volatility on it’s own. It’s not. If anything, the Yield Shield portfolio increases market volatility, and I’ve been very open about that fact. At the end of 2018 went stock markets briefly entered a bear market, we reported that our portfolio behaved more like a 75/25 or an 80/20 portfolio rather than a traditional 60/40.
The power of the Yield Shield portfolio comes from it’s interaction with another concept we talk about here: The Cash Cushion.
To recap: The Cash Cushion is simply a pile of cash you have outside your retirement portfolio in a savings account that you use to tide you over in the case of a recession. We wrote about exactly how this works here.
We recommend keeping 5 years of Cash Cushion when you retire, and there’s a good reason why we came up with that number. To understand why, let’s rewind the clock a bit…to 2008.
Aahhh, remember 2008? Bush was president, everyone with a pulse could get a mortgage, and “sub-prime” was a term used to describe mediocre steak dinners. That shit went south fast after that, didn’t it?
The Great Financial Crisis that followed was the worst economic calamity in decades, and in terms of recessions it was rather unique, in that the crisis originated in, and arguably was caused by both the financial industry and the real estate industry. The two industries that would get hit the hardest in a Yield Shield portfolio, since it would concentrate holdings in mature, blue-chip companies (banks) and real estate (REITs).
Eep. Did the Yield Shield survive? Or does it collapse?
And on this question, there’s a lot of debate and analysis out there in the blog-o-sphere (ugh, I hate using that word) about this. Honestly, I didn’t think we were that influential! And if you wanted to, it would be fairly easy to generate a chart showing the Yield Shield underperformed a traditional indexing portfolio, especially if you were withdrawing 4% from the portfolio as you went.
Here’s the thing: the power of the Yield Shield comes from combining it with the Cash Cushion.
We don’t advocate the Yield Shield portfolio in isolation. We never have. We advocate the Yield Shield combined with a bundle of cash. Because in combination, the Yield Shield plus the Cash Cushion allows you to do something very different important in a downturn: It allows you to reduce your portfolio withdrawal rate without reducing your spending.
For an example, let’s look at 2008.
Here’s how a 60/40 portfolio did assuming you retired right at the beginning of 2008 with a $1M portfolio, withdrew $40,000, and continued doing so throughout the storm. You would have been able to fund some of that $40,000 using dividends and bond income, but you would also have been forced to sell some assets at a loss.
Chart was created using the tool Portfolio Visualizer, and if you want to take a look at the inputs I used, click here.
Now let’s look at the Yield Shield strategy (For Portfolio Visualizer inputs, click here)
Update: A reader noticed that in the original article, the Yield Shield inputs had “Adjust for inflation” accidentally set to “No.” This has been corrected to “Yes” and the affected charts regenerated.
If we bring up a chart of the income we would have gotten during that time, we can see that it actually stayed relatively steady despite the turmoil. It started at $35,000 the first year, then went down slightly to $33,000 before recovering back up to the $35,000 level a year later.
In this scenario, our retiree would NOT have withdrawn $40,000 each year from their portfolio. Instead, they would have harvested the yield and used their cash cushion to make up the rest. How did this portfolio do during under those conditions?
Interesting. When comparing these two behaviours, the Yield Shield + Cash Cushion strategy actually beats a traditional 60/40 portfolio. Yes it was more volatile, but because we were living off just the yield and the cash cushion, we didn’t care, and by the end of 2012, our Yield Shield has returned to its original $1M value, ready to take advantage of the rip-roaring bull market that would have been ahead. Our retiree’s 5-year Cash Cushion would have been depleted, but that’s why you refill it with capital gains when markets rampage, as they did after 2012.
Why is this? It’s not rocket science. The Yield Shield strategy isn’t some magical investment that doesn’t go down in recessions. It simply allows you to do something that every retirement planner agrees works in a downturn: reduce your portfolio withdrawals so that you don’t sell assets. And it allows you to do it while keeping a relatively small amount of cash sitting on the sidelines of just ($40,000 – $35,000) x 5 = $25,000. We didn’t need to keep hundreds of thousands of dollars of cash out of the market, because that would have been a huge drag on our long-term performance, not to mention delay your retirement.
And that’s during 2008, a once-in-a-generation confluence of events that caused the Great Financial Crisis. In a more “normal” recession like the one in 2001, the Yield Shield outperformed a traditional 60/40 portfolio even more.
(Source: Click here for inputs. Note that I had to swap out some assets in the Yield Shield due to not enough price history in the tool).
The Yield Shield Is Not a Forever Portfolio
So to recap, over the long term the Yield Shield portfolio will underperform a pure indexing portfolio. But in a recession, it, combined with a 5-year Cash Cushion, gives you the ability to reduce your portfolio withdrawals without sacrificing your spending. And since the first 5 years of retirement are the most dangerous due to Sequence of Return Risk, we only advocate for pivoting towards Yield for the first 5 years of retirement.
Personally, we retired in 2015. Since then, we’ve experienced 2 down years: 2015 due to the oil crash, and last year when our portfolio dropped 5.66%. In both cases, we were able to harvest the yield, use up some Cash Cushion, and not sell anything. And in both cases, the subsequent rebound took our portfolio even higher. When we retired our portfolio was $1M. Now it’s sitting around $1.1M.
That being said, we are now into year 3 of our retirement, so we’re starting to approach the point in which we’ll need to drop our Yield Shield assets and move back into the fold of traditional indexing. Personally, we’re planning on doing this in stages: half next year, and half the year after that, and we’ll document exactly when/how we go about doing that on this blog.
So that’s how the Yield Shield protects you in recessions. Questions? Comments? Let’s hear it below!
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You guys math shit up like no others and I am so here for it. Thanks for the analysis!
We do enjoy math every now and again. Thanks for reading!
Apparently, for the godfather of Sequence of Returns Risk (Big ERN), the entire yield thing is an illusion, and his math is much more convincing than the one presented in this post.
Can you share if/if not/to what extent you agree/disagree with the latest earlyretirementnow post?
You’re entitled to your opinion. I showed the math and the yield did not get significantly cut. If you don’t like my solution, feel free to use your own.
I was perplexed by the discrepancies between Wanderer’s charts vs. ERN’s until I started playing with the Portfoliovisualizer. Turns out the Yield Shield performs better or equal to a 30/30/40 except if you start the calculation in 2007. Starting in 2009 the Yield Shield is much better. 2016 is fairly similar. This is talking about 2019 end date.
Given that it works pretty well every year except for 2007, I think we have been played by ERN in his hope to make a point.
Very astute observation you made there! Thanks!
@ giblets: No, it doesn’t.
Portfolio 1 = Yield Shield
Portfolio 2 = 30% VTI, 30% VEU 40% BND
Portfolio 3 = 30% VTI, 30% VEU 40% IEF (replace agg bond market with safe Treasury bonds only)
P2 performs $55,000 better than the Yield Shield
P3 performs $160,000 better than the Yield Shield
This shows that pumping up the yield exposes you to more Sequence Risk. Also, notice that this is all independent of international exposure. Anyway, if you want, keep believing in the Yield Shield. Good luck!
October 2007 – January 2019 (you started your sim not at the peak. Nice try, but I’m smart enough to spot that attempt to fudge the simulation like that!)
$40k withdrawals, adjusted for CPI
https://www.portfoliovisualizer.com/backtest-portfolio?s=y&timePeriod=2&startYear=2007&firstMonth=10&endYear=2019&lastMonth=12&calendarAligned=true&endDate=02%2F25%2F2019&initialAmount=1000000&annualOperation=2&annualAdjustment=40000&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=1&absoluteDeviation=5.0&relativeDeviation=25.0&showYield=false&reinvestDividends=true&symbol1=VTI&allocation1_1=15&allocation1_2=30&allocation1_3=30&symbol2=VYM&allocation2_1=5&symbol3=IYR&allocation3_1=10&symbol4=VEU&allocation4_1=30&allocation4_2=30&allocation4_3=30&symbol5=BND&allocation5_1=10&allocation5_2=40&symbol6=LQD&allocation6_1=10&symbol7=PFF&allocation7_1=20&symbol8=IEF&allocation8_3=40
@ERN: Your point only works in 2007. Any other year the Yield Shield does just fine. We all know market timing is a fools game.
But, if you insist in saying the Yield Shield doesn’t work when started in 2007 and 2007 only, then you are correct.
Every other year it works just fine or better, which is good news for people not timing the market.
As for Portfolio 3, forget about it.
Bonds vs Treasuries is a matter of preference which doesn’t really pump the dividend that much. I prefer treasuries myself but that is not the point of the exercise.
Do the exercise yourself. Same values you have Oct 2007 to Dec 2019. Change only the year. Every other year except 2007 the Yield Shield is equal or superior.
So, just because it doesn’t work in 1 year out of 11 years, we must conclude it is garbage because you say so?
@ERN: The more you open your mouth the more I realize you are way wrong.
I dare you to find any year where an American Yield Shield portfolio underperforms substantially (more than 5%) an American 60/40 portfolio, from X year to 2019. More often than not the Yield Shield performs better.
If you are an honest “academic” person, you are going to have to rewrite your article explaining why a Yield Shield portfolio performs better than a 60/40 portfolio and why you got it wrong to begin with.
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&mode=2&startYear=2007&endYear=2019&initialAmount=1000000&annualOperation=2&annualAdjustment=40000&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=1&absoluteDeviation=5.0&relativeDeviation=25.0&portfolio1=Custom&portfolio2=Custom&portfolio3=Custom&TotalStockMarket1=60&TotalStockMarket2=45&TotalBond1=40&TotalBond2=20&LongCorpBond2=20&REIT2=15
Same thing with an international 30/30/40 vs Yield Shield portfolio:
https://www.portfoliovisualizer.com/backtest-asset-class-allocation?s=y&mode=2&startYear=1995&endYear=2019&initialAmount=1000000&annualOperation=2&annualAdjustment=40000&inflationAdjusted=true&annualPercentage=0.0&frequency=4&rebalanceType=1&absoluteDeviation=5.0&relativeDeviation=25.0&portfolio1=Custom&portfolio2=Custom&portfolio3=Custom&TotalStockMarket1=30&TotalStockMarket2=15&IntlStockMarket1=30&IntlStockMarket2=30&TotalBond1=40&TotalBond2=20&LongCorpBond2=20&REIT2=15
Of course, the YS portfolio performs better most of the time. Just not when need it to protect from a recession/bear market.
Thanks, Mr. RIP!
It will be very hard to disagree with my SWR Part 29 post. A simple 60% IVV + 40% AGG portfolio would have mopped the floor with the Yield Shield.
Also, make sure you all look at the details of the calculations above! If you look at the PortfolioVisuzalier Link you’ll notice that 1) the withdrawals are NOT adjusted for inflation, 2) the portfolio value time series is NOT adjusted for inflation (so getting back to the initial portfolio level is not enough!) and 3) a simple 60/40 portfolio would have performed better than the Yield Shield. 4) And also, that non-adjusted initial withdrawal was only $34,400 (not $40,000) and this figure would now be eroded down to $28,800 after inflation. So, if the Yield Shield is designed to secure the 2.8% Safe Withdrawal Rate it certainly succeeded. 4%? Not so sure!
The Cash Cushion is also a Red Herring. A 60/40 with cash cushion would still do better than the Yield Shield with a Cash Cushion.
I also noticed you took down the link to my post in Mr. RIP’s comment. It wasn’t a spam/commercial link, but one with pertinent information. That’s not very nice blogging etiquette! First time I ever see that! I would never do that on my own blog! But you are certainly entitled to your own rules.
ERN is really focused on pointing out links to his blog are missing… why should you care that much.
Also you inflation adjustment seems extremely high for a 5 year period. do a CPI inflation calculator.
Inflation adjustment is for 2007-2018. I did my calculations 2007-2018.
Bloggers care about SEO. I linked to the post by Millenial Revolution. It’s the courteous thing to do. Maybe it’s because I have an academic background where it’s considered unprofessional not to mention opposing views. Or even worse, actively erase those opposing views from the record. But you can’t always assume others feel the same way.
Thanks BigERN for your analysis, I ran the same simulation from Oct 2017 to Today using the Permanent Portfolio (25% VTI, 25% LQD, 25% GLD, 25% BND). and it has outperformed the other portfolios including the standard 60/40 and the YS .. The disadvantage PP under perform on normal bull market due to lower equity allocation.
In fairness of comparison, the 60-40 portfolio on BigERN’s blog is all invested in the US and would be way too much currency risk exposure for most non-US residents. Secondly, it outperformed because the S&P 500 outperformed international indices post 2011 (as is shown on that post) which is not something one can predict. The fairer comparison with the Yield Shield portfolio is the 30% US, 30% Intl, 40% Bond portfolio which BigERN demonstrates to be a slightly less volatile but otherwise similar performing portfolio to the Yield Shield. BigERN also does a nice job demonstrating that this volatility is mostly due to the strong correlation with preferred shares and equity indices. Lastly, the cash cushion (and difference between monthly and annual withdrawal schedules) are not complete red herrings, they essentially explain the (albeit small) differences in the portfolio calculations they each made (if you inflation adjust both or neither).
Conclusion: Is the Yield Shield a complete protector from all SoW risk?… No. Is it crushed by a portfolio with a similar global equity exposure?… No. Perhaps one can argue that it allows you to have a smaller Cash Cushion and thus a slightly larger investment portfolio. It would be nice for someone to do that math to see because we all know that having more investments is 100% correlated with retirement success.
Exactly. The value of the Yield Shield is the fact that you can make it with a much smaller Cash Cushion that normal. After all, a traditional 60/40 portfolio that yields maybe 2% would require ($40,000 – $20,000) x 5 = $100,000! That amount of cash would represent a pretty big drag on your performance.
See? This guy gets it.
I think you did a great job, I like Dividend’s, and as i approach my retirement goal in 5 years, its a great way to minimize risk, without completely pulling out of equities.
Just don’t get conned by dividends of 7 and 9% from individual stocks, they are just as speculative as any other Equity.
cheers
Absolutely. Many a dividend chaser got dashed against the rocks of unrealistically high yields. That’s why I didn’t build my Yield Shield with individual stocks/preferreds. Too easy to get creamed that way.
Just to add some oil in the fire, I wonder how a portfolio with rental properties used as a yield shield would have done from 2008. I’m pretty sure it would have doubled the portfolio value! lol… 🙂
If you had cash handy during 2008/2009, that would have worked. But psychologically buying real estate during the housing crash would have been even harder than buying into the index like we did. Hindsight’s 20/20, right?
We actually bought our single family rental property in March 2012, which turned out to be almost the very bottom of the housing crash in our local area (according to post 2012 Zillow price history charts).
We originally were planning to wait until after I retired* in August 2013 to buy a rental property, but decided to take the purchase leap in 2012 for two reasons:
(1) We thought it likely that house prices would start to go back up sooner rather than later.
(2) We thought it would be hard to qualify for a mortgage with only our pension incomes.
This was definitely a once in a lifetime occurrence of (unintentionally) timing the housing market to buy at the bottom. LOL
* One of us had been wanting a rental property for a long, long, LONG time. The other of us (ummm … ME) had been procrastinating for the same duration, since who wants to do all that land lording “side hustle” work while still having a stressful 40+ hours per week day job in the cube farm??? 😉
What evidence do you have a global equity portfolio out performs a US 60/40? The global equity portfolio using a bogglehead 3 formula significantly under performs the 60/40 and is a poor choice of portfolio. If you analyze the portfolio visualizer efficient frontier the bogglehead 3 global portfolio vs the 60/40, the global expected return is 8.97 with a 11.96% SD while the 60/40 predicts 9.17% return with 9.32% SD making the 60/40 a superior portfolio, more return with a lot less risk. If you monte carlo a BH3 vs a 60/40 for the same WR and SOR, in the best SOR case the BH3 fails 10% of the time while the 60/40 has a 2.5% failure rate. The spread gets far worse as the SOR is adjusted to a more dire scenario. In a worst 3 years first scenario BH3 survives only 54% of the time while a 60/40 survives 81% of the time. If you’re riding a BH3 into the future better keep those Walmart greeter skills razor sharp.
If you live in the US, a basic 60/40 is a perfectly fine option. For those of us not living in the US, buying the S&P 500 IS buying international equity. Roles reversed (to Americans), imagine holding 60% of your portfolio in Canadian dollars for example. This is a huge amount of foreign currency risk. If you want to see the huge effect this has swap out VTSMX for VUS.TO (S&P 500 ETF in CAD) in PortfolioVisualizer in a basic 60/40 for example – it changes the annual return by over 3 percent! (for 2014 to 2019 which is as far back as VUS.TO goes)
For non-US residents our domestic markets often don’t have enough equity diversity by sector to be a one-stop-shop. About 60% of the Canadian market is just financial and energy sector stocks for example. Consequently, we need to buy at least some foreign equity for sector diversification, again remembering that the US is foreign to us, and hence increase our currency risk. Now, you can help mitigate the effect of currency risk with hedging (a drag on performance as this has a cost) or diversification – holding a variety of domestic and international equity, both US and otherwise. Most people recommend diversifying as the better option and hence the reason for holding a variety of international equity. For US residents it’s less important to hold international equity because you have a broad market (by sector and by the multinational nature of your large companies) and so it’s a more debatable topic – one which I have no strong opinions on.
Your point is taken. Swap out to Nikkei 225 and you pull out the old blue steel revolver and shoot yourself in the head. The point is to not play gotcha semantics with “who is foreign” but to look at the risk reward pairs generated on the efficient frontier plane. Buying more risk for less return is a poor choice no matter where on the planet you reside. Personally I have no problem owning China or Russia EXCEPT their market are rigged, the numbers are unreliable and they have no rule of law. Other than that they are smashing investments
Thank you for a great article on your website. It’s empowering to see different points of view.
Thanks so much for the deep dive! Also I need “Charts Or It Didn’t Happen” on a t-shirt ASAP.
Ooh! Merchandising opportunity!
No plan is absolutely perfect, albeit some might be better than others. I’ll take a good plan executed perfectly over a perfect plan that doesn’t get executed. IMO, the fact Wanderer has a reasonable plan, and he’s working it with intention, makes the odds of long term success very high. He’s also more than willing to adapt if circumstances change, another predictor of long term success.
SRR is one of those things that used to really make me sweat. We plan to fat FIRE at 55 and have several layers to guard against SRR, from a juicy defined benefit government pension indexed to inflation for her, to seven figures in real assets we could borrow against to cash flow through a black swan event, to what many would consider an egregious cash account. We’ll only have shot at getting this right in seven years and I plan to make it hit the bull’s eye.
Wanderer, keep up working the plan!
Wanderer, how do you marry your findings, and ERN’s, with the established knowledge that most stock market gains actually come from dividends?
Oh, I disagree with that. The S&P 500 gains on average 6-8% long term, and has a dividend yield of 1.5%-2%. That’s not “most.”
When you’re accumulating you don’t particularly care where the gains come from, as you’re going to be reinvesting dividends anyway, but when you’re retired, the source of your gains (income vs. cap gains) becomes much more important, because you want to avoid selling at a capital loss if at all possible. That’s how you lock in losses and join the unfortunate 5% of failed retirees.
The commenter isn’t too far off the mark. Remember Wanderer, that yields of 1.5-2% are a recent phenomenon. In the past, yields were considerably higher and multiples paid for stocks considerably lower.
According to the research of decades long past, dividends accounted for *around half* of the return of the S&P. I believe Prof. Jeremy Siegle’s books covered that data set in “Stocks For The Long Run”
It wasn’t until the 1990’s that S&P yields dipped under 3%. At roughly the same time US GDP fell from around 4% annually, to under 3%.
This is one of the reasons why entities like John Bogle have predicted lower returns for the S&P. Multiple expansion has juiced returns in recent years, but it can’t go on forever.
Some argue the era of low yields is at an end now that interest rates are rising again, and the next recession will create a reversion to the mean. We’ll have to see how it works out.
Very nice! To be honest, a pension + 7 figures in real estate + massive cash cushion seems a bit overkill but hey, you do you buddy! Whatever makes you feel safe enough to jump, you do you!
I’ve been doing me 24/7 for too long to do anything else. 😉
As an engineer I’m sure you can appreciate redundancy upon redundancy built into a system so it never really gets stressed. We when jump, and turn that earned income faucet off, it ain’t never going back on but the lifestyle continues. That’s our dream and we’re just seven years out.
“if they happened to retire right before a bad bear market, they’d be forced to sell into a down market. ”
This is exactly why investing in a dividend-growing portfolio makes sense. YOU NEVER HAVE TO SELL A SINGLE SHARE. You’ll live off your dividends and it doesn’t matter if will return a little less than the index because in return you’ll get LESS VOLATILITY and it will give you piece of mind to actually sleep well at night and don’t panic sell or even have to sell shares in a bear market.
Would you give up this piece of mind to get a few more basis point of return? I was once an pure indexer but I’ve reassess that because I don’t want to have to sell in a bear market and don’t want to sit in cash which BTW will also drag down my portfolio returns.
It’s actually a very different mindset pre- and post-retirement that most people don’t appreciate since they’ve never been through it. I’ve also had to make that choice, and while the total-return math suggests I should just go “fuck it! Sell at a loss, it’ll probably be fine!” I just really really REALLY don’t want to be part of the 5% that fail.
I’ll return to indexing in a year or two though, so I’m not planning on getting too comfy as a dividend investor.
BINGO!!!!!!!!!!!!!!!!!!
we have a winna!!!!!
we just raised our cash position last year to around 15% and that would get us 5 comfortable years without selling anything. the caveat is that we’re on the older side of your audience, at 50 and 55. we worked enough in the u.s. so that social security is a real likely thing for us and we only need the portfolio to do heavy lifting for 7 years before the first social security annuity kicks in. i buy individual stocks but did some research a wrote last year about the nasdaq 100 beating the sp500 over a long period so we allocate the growth part to those QQQ high flyers. i don’t think it’s that much different from what you describe but with a few more moving parts. i don’t mind the complications as i enjoy this stuff.
Phew, 15% cash is a LOT of cash. But whatever, full Social Security will likely fix everything.
Can get CD paying a bit more than 3%.
Sweet! From who?
Thanks for the post!
My only concern is that a Dividend or a Yield is just a forced return of capital. In a recession, isn’t it the same as just selling assets when the market is low?
No arguments against the Cash Cushion, I think it’s the non-debatable counter to SSR. And if the market doesn’t go down in the first 5 years, great, invest it!
Absolutely not. If you sell assets at a loss, you have less of them to participate in the inevitable recovery. If you just take your dividend cash and run, you still get to participate.
Any chance you could write a post on how you pivoted from your growth/investing pre-FIRE portfolio to this “yield shield portfolio”? How does one sell shares from their current portfolio to then buy these yield shares without a tax hit? Maybe I’m over complicating things?
Seems to be a lot of over complicating going on these days.
Honestly, it’s not worth an article. The truth is, I had enough capital losses accrued from 2008/2009 to offset any capital gains I realized in my pivot.
Thanks for the post and interesting strategy wanderer. In regards to comments above, let’s remember that there is more than one way to skin a cat and if anyone is trying to provide value by sharing a portfolio strategy on their own blog I welcome it. There is no requirement to unify strategies across all blogs. I for example like to think about things from an overall return standpoint and lean quite a bit on my passive income and cash cushion for when the downturn comes. I also am of a certain age and net worth unique to me. To each her/his own. Thanks again.
Exactly. Though have you ever thought about how weird that phrase is “There’s more than one way to skin a cat?”
Who is the monster who came up with that? And why do they have so much experience skinning cats?!?
It takes a lot for me to lol and you did it. You are totally right and I have never thought about how serial killery that phrase is. I am never using it again.
I was once part of a student newspaper and one of our joke articles was a list.
“1,001 Ways To Skin A Cat”
Yes, we actually wrote 1,001 entries on the list. “Incisive wit” was my personal favorite.
Sincerely,
ARB–Angry Retail Banker
The phrase actually refers to skinning catfish, not felines. But yeah, that would be bad if it was cats haha.
WOW this was legit amazing lol. Thank you so much for writing this and for showing us the math and the graphs. Okay, so from my understanding life after FIRE is dynamic and requires adapting and adjusting to market conditions, while balancing how we utilize the yield shield with our cash cushion. And then during the boom times, to shore up our cash cushion for the next future lean time. Sounds do-able lol 🙂
Exactly. See, this guy gets it!
Must admit I struggle with this one. It just sounds too good to be true.
An additional complication for me personally is the fact my local index (UK) currently has a dividend yield of over 4.5% However it has also gone precisely nowhere over the last 18 years. So deciding whether to invest in FTSE index with high yield or a more internantional index mix affects the level of my initial yield.
To compensate I hold a much much larger cash cushion. In fact that cushion also includes a chunk of silver. [Why Silver – As UK interest rates are so low not much lost in income and if the shit really hits the fan in the markets it may rise in value just when I want it most. If performance sucks as markets go up then I do not care. And silver was historically much cheaper relatively to gold when I was buying.]
Wow, 4.5% yield…I could live off this forever without touching my principal
you lucky bastard lol !
Well that is the tempting thought process. But is it legit?!
I am sure the Venezuelian divy yield is much much higher but, maybe, there are good reasons for it?!
I am overweight UK but not all in. I have substantial equity positions in Europe, USA & Australia too. And yes anyone able to even think about this stuff, let alone comment on blogs like this, is one lucky bastard!
Errrrr the news out of the UK has been…alarming to say the least. I hope you guys make it out of Brexit OK, but…eep!
Brexit is the shaggy dog story that keeps on giving. The weird thing is bad news on Brexit generally results in the FTSE 100 going up rather than down. This is usually because Sterling falls and most of the earnings in that index are not in Sterling.
At the risk of being complacent we have been through much worse – a couple of world wars, 70s hyper inflation and oil crises, small recession in 80s, big recession in early 90s – house prices in my area fell 25% in that one – the only time UK house prices have fallen in my lifetime, 2000 crash, 2008 global financial crisis.
So, yes, it is a terrible own goal – true if you wanted leave or remain – but I really do not think the world is going to end whatever the eventual outcome.
“That’s 3.5% of $1 million, or $35,000, that we get paid regardless of whether our overall portfolio goes up, down, or sideways”
These are all pre-tax figures. How about income taxes? For Canadians 15-20% taxes need to be paid if these dividends are from Canadian companies. If these stocks are US then Canadian Income taxes can be up to 50%.
With no other income, you pay no taxes on investment income if you structure your holdings in the right accounts. Check out the Investment Workshop for exactly how to do that.
Thanks for the post! I’ve gone with CC 100% index stock funds. Everyone needs to determine their own level of risk and what they would do in a down market. My yield shield/cash cushion is that I continue to work part time 10-12 hours a week. Thanks to your blog my expenses are way down and I can still put money away working so little. I have never believed in retire from helping people retirement. All the FI blogs are helping people, I don’t have that talent so I help people in other ways and get paid for it.
We all have to determine for ourselves what works best for us, thanks guys for so many choices. THANK YOU AGAIN!
Part time work/Side FIRE/Partial Fire all act in the same way as a Yield Shield, so if you can do, all the more power to you. Plus you get to keep your skills up to date and help people, so win/win!
I am in the accumulation phase for the next two years and am starting to think about how I will do withdrawals. I will have a pension that covers about 35% of my expenses so it will act as a yield shield/bond portfolio. I plan to stay fully invested in a VTSAX type fund and withdraw only dividends. SS will kick in after 6 years. Everybody situation is different.
Really enjoyed reading this post. Now, isn’t this pretty much like doing a bond tent but keeping the extra bonds as cash? I think it could be better to keep this cash cushin as extra bonds in your “forever” portfolio, since it’s got more yield and should behave favorably in case of recession. Start with 55 to 60% in bonds instead of your 40%, and reduce gradually over the next 5 years as sequence of returns risk wears off.
That would work if traditional government bonds weren’t yielding so shitty. Last I checked US treasuries were yielding 2.5%. My Cash Cushion would need to be so big with a yield that low that I would materially impact the performance of my portfolio by keeping so much of it uninvested.
Careful with dropping the yield as you are making one huge assumption : past performance will repeat itself . You could very well be selling capital in 2020 . Good luck !!
(Nice market rebound , helps fuel recency bias . How the hell was your 60/40 portfolio
down nearly 7% in 2018!! That a misprint?)
That WAS a misprint. Actually, we were down 5.66%. Article has been fixed, nice catch!
One thing I do not hear discussed in the battle between ERN’s opinion and Wanderer’s strategy is what about looking forward? Now I get it no one can predict future returns. But ERN’s suggestion that 60/40 would win takes into account Bond returns that are higher due to a period of declining rates. Can you count on that going ahead?
Or will a blind 40% allocation to Bonds end up doing it’s job of reducing volatility but overall not helping performance (like it did from 2007 to 2012 and beyond) making comparisons to a period like 2007-2012 a poor example of the two strategies future prospects?
Nobody can predict the direction of future interest rates. Except MAYBE the chairman of the Federal Reserve.
Pick your asset allocation based on your risk tolerance. Don’t try to to market-time bonds, it’s just as tricky as trying to market-time equities.
Thank you for yet another informative post. And more generally, I want to thank both of you for your blog. You helped to inspire me and my partner to rent after we sold our condo, and aim for FIRE. We are now only 2 years away from FIRE!
After we “mathed the shit up”, we decided not to buy. We would have been living hand-to-mouth paying off a $500k mortgage plus other costs. Despite our family and friends’ skepticism, we rent – and we are SO HAPPY!!! Our landlord is great. We don’t have a care in the world when it comes to house maintenance. And, since late January, we have increased our sale proceeds by $18k through investing.
The timing of our decision to rent couldn’t be better. Both of us liked our jobs until recently, because rule changes mean more hours and less vacation. Coworkers are disgruntled and stressed, but they feel powerless because their jobs are not in demand, and they have mortgages and little saved. But my partner and I are relatively serene. With “FU money”, we don’t feel trapped knowing that we can quit and take long unpaid leaves.
All of this is to say – thank you so much for making your story public. You started us and many others on the journey of FIRE. And with your continued posts you keep inspiring us to keep going!
YOU are awesome! Congrats on everything you’ve achieved! And remember, if you want to prove your co-workers wrong, live life well. Sounds like you two are pulling it off!
Thanks Wanderer! Having “FU money” allowed me to tell management about the employees’ misgivings without fear of repercussions. Apparently I was the first and only one to speak up on behalf of all the employees. Funny enough, management seems appreciative of my input.
I feel so powerful with the ability to speak my mind and help my coworkers. Ah, the power of FU money!
This is quite possibly the most-motivating thing about being financially-independent…
I’ve commented on this matter before on your site. I’m with Jeremy. The preferred shares are introducing way more volatility into your portfolio without the appropriate return compensation. (Stock-like volatility, lower-than-stock-like returns.) I don’t think that is worth the mental compensation for not having to sell some of your principal during a downturn. I think you are building a portfolio that is slightly less rational to sync up with your own psychological makeup–which is actually a good idea, but maybe not something to counsel others to do in general. Cheers!
There is something to that. The volatility we saw in December was pretty intense, but on the other hand I enjoyed the dividends immensely.
But hey, it got me out of Sequence of Return Risk, so can’t complain!
Just chart the volatility of the preferred share funds you own from Jan 1, 2008, to Jan 1, 2010. We aren’t in Kansas anymore, Toto. 😉 Also, in fairness to you, Jeremy’s scenario is totally hypothetical since he actually doesn’t have to sell much (if anything) due to blog income. Hypothetical and real life in investing are often radically different in terms of the psychological experience. I myself have never had to sell equity shares during an up or a downturn to finance my lifestyle. Like you guys, I have other income and/or dividends (though not preferreds!). Keep up the great writing ;).
Why do you guys care about the market outperforming you? Your portfolio will, at a minimum, go up at the rate of inflation while also yielding an inflation adjusted 35k a year. If you guys want to switch so you have more wealth down the road do you really need to switch to a capital gains based portfolio? You guys still make money off of this blog too right? I’m sorry maybe I’m being an idiot. Thank you guys for writing this blog, it has helped me and my girlfriend a lot in our planning our FI journey after college:)
Honestly, it’s because the assumptions behind the 4% rule were based off an index portfolio. The further I stray from those assumptions the less the 4% rule applies, so that’s why I want to pivot back.
I think pivoting back is wise. You are so young that you really want that historical market performance over the coming decades. It could make a MASSIVE difference to your lifestyle when you are 70 and older.
recessions have a unique way of bringing out the future side hustle millionaire in aspiring entrepreneurs. Agree?
Nothing wrong with a good side hustle. Keeps up the skills and brings in additional income. Win-win!
Gotta love those side hustles! 🙂
Hey wanderer thanks for the article, enjoyed it as always! But in the end I’m confused because of the divergence of opinions between you and big ERN?
I was also wondering if you knew about the following articles from Dan author of the CCP blog? Those are all about debunking dividend myths :
-https://canadiancouchpotato.com/2011/01/18/debunking-dividend-myths-part-1/
-https://canadiancouchpotato.com/2011/01/20/debunking-dividend-myths-part-2/
-https://canadiancouchpotato.com/2011/01/24/debunking-dividend-myths-part-3/
-https://canadiancouchpotato.com/2011/01/27/debunking-dividend-myths-part-4/
I’d like to have your opinion and Firecracker’s on that if you have time! 😉
Oh, thanks! I will take a look at links you mentioned.
If you had $1M in aristocrat dividend stocks yielding 4%+ only in dividends wouldn’t it be safer? I mean, you’d never have to sell a share and, even though you might underperform a bit the S&P index on a bull mkt (overperform in a bear tho), you’d still have the 4% rule covered only by the DY and whatever capital appreciation (you’d sure have) would be extra to grow and compensate inflation and all that.
I find it way safer than pure relying on the index performance and having to sell shares.
If I were you Wanderer I wouldn’t go back to pure indexing…think this twice.
Dividend aristocrats aren’t paying 4%. They’re paying maybe 2.5%. Where are you seeing this?
Not the ETF but the 16 highest yielding ARISTOCRATS average 4%
AT&T Inc.
AbbVie Inc.
Exxon Mobil Corporation
Chevron Corporation
People’s United Financial Inc.
Consolidated Edison Inc.
Coca-Cola Company (The)
Cardinal Health Inc.
Kimberly-Clark Corporation
Target Corporation
Leggett & Platt Incorporated
Archer-Daniels-Midland Company
PepsiCo Inc.
Franklin Resources Inc.
Federal Realty Investment Trust
T. Rowe Price Group Inc.
I’m curious, for your charts and data, are you using total returns (yield plus appreciation) for your yield shield portfolio or only appreciation since you are consuming the yield and it is not contributing to the recovery? Dividends contribute a significant portion of total return and that may skew your data if you are not taking that into consideration.
Total returns. The PortfolioVisualizer tool takes into account withdrawals.
The problem with the yield shield argument is while you don’t sell any shares you don’t buy any shares either, and it’s the purchase of shares that is the motor of growth. That is what dollar cost averaging is all about, the purchase of shares. Shares purchased over time = wealth especially if you buy low. That’s what re-balancing is all about. The ROI if you live off yield goes in the toilet. I like the “cash cushion” except it doesn’t go far enough. The cash cushion should really be a tangent portfolio. Use money from the tangent portfolio to live on when your last years YTD was negative and use the dividend to buy shares low, also re-balancing if it really hits the fan. Otherwise let the tangent portfolio just grow till needed and cash in on some of the growth, but not all of the growth. Let some growth continue to grow. In my opinion you need to cover bad SOR for the first half of retirement, or until the tangent portfolio runs out of money. Once out do not refill and just move to the higher risk portfolio for living expenses. By doing this you will have front end loaded and the back end will cover itself with excess growth.
That would be an interesting comparison. YS with vs YS without rebalancing, vs SP500 with vs without rebalancing.
Thanks for the article and the interesting discussion.
Totally agree that the reinvestment of dividends is a major source of growth. But, as I’ve realized, the math pre-retirement is very different post-retirement.
That being said, while our own personal post-retirement experience has been a bit rocky, it’s still worked out great so far 🙂
Not being critical but I worked through several SORR for the past 30 years. It turns out there are something like 5 or 6 down years out of 30 so those are the years you need to not sell stock but buy stock in your high risk portfolio. For those years you need a separate source of funding what I call a low risk fund and I define it as the tangent portfolio which is about 16/84 depending on your bond choice. The tangent fund by definition is the ultimate efficient investment because you get the most return for the least risk. The second fund is a growth fund like a 60/40 or 70/30. You monitor the YTD return and if it’s negative you take money from the low risk fund. Since the low risk fund is mostly bonds it’s pretty much immune to SOR. In a 50% stock drop 16% would drop only 8% so 92% of your funds would be available for hamburgers. If YTD is down the next year do the same thing. Generally the YTD goes positive in less than 2 years even if the crash is major. The exceptions 1973 and 2000 which took 3 years so you need 3-5 years WR to cover the most likely scenarios. The high risk portfolio always reinvests dividends so you don’t need any special dividend oriented fund S&P will do fine. Always re-balance every year even n down years. On the way up you will be selling a little high each year and stashing that in bonds. Come the crash you take some of that bond dough and buy low and the whole thying is run mechanically and is controlled by the AA. Buying low is a supercharger and will power growth in excess of your WR by a mile. That growth will add growth year after year after year as long as the economy is expanding. If the economy deflates like Japan did in 1990 this technique won’t save you but no equity based technique except selling short would have saved you. It turns out SOR is most severe on portfolio longevity when it occurs in the first half of retirement and especially severe when the crash happens not the year but the year after you retire so 2000’s effect was most severe in 2001 and 2007’s effect was most severe in 2008 when you are pulling money out of a deflated portfolio to buy hamburgers which is why you switch to low risk in bad times and live off growth in good times. In the second half of retirement you are racing to the grave so you probably will run out of breath before you run out of money. That’s why I don’t bother refilling low risk if it runs out of money because once you front end load by not selling in a down market and re-balancing the added growth is felt decades in the future. Too much risk in the high risk is also deleterious. I’ve read academic studies that discuss a sweet spot that occurs between too low of risk as in say a 40/60 vs too much risk as in a 80/20. In a 90/10 if the market falls 50% your stocks fall 45% which means it takes 90% growth to recover and 90% growth takes a long time. It took the S&P till 2013 to fully recover it’s 2007 highs and start making money again. 6 years is a long time. In a 60/40 if stocks fell 50% the portfolio falls 30% and needs 60% to recover. 60% recovery happened in 2011 far sooner than the more risky portfolio. By buying stock cheap in the down years you can sell appreciated stock in the up years so you sell less of it to buy the same number of hamburgers. This whole scheme is built around the idea of buying low and selling high and because it’s mechanical it’s risk management is not subject to humans. In the up years the low interest portfolio makes money as opposed to just sitting there in cash. It doesn’t make a ton of money but it will extend the low risks life span. If you have low risk dough left after the half way point just add it to the high risk. The difference between being retired and being employed is the assumption of your own risk from your employer and how much your future is leveraged. If you have 1M and you take out 4% for 60 years you will need that 1M to produce 2.4M of income which is about 2% over inflation. When you are working you are not levered because the work buys the hamburgers and the healthcare. Choosing a strategy that under-performs the leverage in my opinion is poor risk management.
You might say 2%! Hell anybody can make 2%. In the decade from Dec 1998 to Dec 2008 the S&P without dividend reinvested LOST a bit more than 3%/yr. With dividend reinvested the LOSS was only 1.4%/yr. If you inflation adjust the S&P with no dividends for that decade LOST over 5.3% and with reinvest LOST 3.8%. That’s why they call it the lost decade. Over the 20 years from 1998 to 2018 the S&P with no dividends made 1.7% (less than 2%) and with re-invest 3.6%/yr over that 20 years. 20 years is 2/3 of a 30 year retirement. I’d be biting my nails and hoping I don’t get cancer. There are people alive and retired today living out this scenario, so it’s real and not cherry picked.
Here is a good calculator to play with https://dqydj.com/sp-500-return-calculator/
Hi!
About this: ($40,000 – $35,000) x 5 = $30,000
Let’s math the shit up again guys!
$40,000 – $35,000 = $5,000
$5,000 x 5 = $25,000, not 30
Wanderer: Do you have any of your Cash Cushion in GICs? If not, why not? I’m wondering if it’s something worth doing. Thanks
Ok, so here’s my question for you.
You guys are in your 30s and can look forward to perhaps another 60 years of retirement. But doesn’t your yield shield address sequence of returns risk for a 30-year retirement? Why would you abandon the yield shield in the next few years rather than a couple of decades down the road? How do you conceptualize the extent of your sequence of returns risk for the next 2 or 3 decades?
Thanks! Love your stuff!
Very good series of articles. Next month I am completing 5 years on retirement. I am 46, and I still dont think I should turn down any kind of defensive strategy, as the Yield Shield. The next crash could happen next year, or in 10 years, and I would still have 30-40 years of retirement. Maybe this 5 years rule serves to regular folks retiring on 70 and living up to 80 or 90 years. So, I would advocate early retirees keep these defensive strategy longer. What do you think? I would be glad if you have a good argument, so I could be shift to less defensive strategies and expend more. I currently live just on my dividends and interest, not even a cent on capital gains. I do sell and make profit regularly, but I reinvest everything back, after paying taxes.
Thanks so much for this post (especially the charts). I’ve read about your yield shield many times but I never “got it” until now.