Two Pounds of Chopped Livin'

"Monte Carlo Mojo" (posted here July 15) said using mutual fund withdrawals as the primary means of living on a portfolio is 'Russian Roulette, Monte Carlo style,' advocating instead 'low sweat' investing in high quality fixed income investments and stocks with rising dividends.

But let's face the ugly facts in the mirror, dividends have taken a pounding, chopped even by companies with decades of dividend growth. Yet amid what Morningstar called the worst period for dividend cuts since 1938, investors living on their portfolios (or planning to) are still better off with the low sweat approach.

To illustrate, total returns for the Morningstar category 'Moderate Allocation' (a.k.a 'Balanced Funds,' which combine stocks and bonds, making a fair proxy for a typical experience with a mix of stock and bond funds) dropped on average 28% in 2008, then gained about 7% through June 2009. So if a level headed investor withdrawing 4% in 2007 wanted to maintain that prudent 4% long term withdrawal rate, it meant taking a 28% income cut for 2008, and only a small improvement to 26% less income by June 2009.

Worse yet for investors who needed to maintain that 2007 income level. They'd have to increase their withdrawal percentage to about 5.5% of their shriveled portfolio, increasing to as much as 1 in 3 the chance of going flat broke in retirement, even with a traditional mix of stock and bond funds. Hairy scary stuff.

And how would low sweat investing compare? Diversified portfolios of stocks with a history of rising dividends (illustrated here by ETF tickers PFM, SDY and VIG) show a 2008 dividend cut of 2% for PFM but increases of 12% for SDY and nearly 18% for VIG. Low sweat so far, though 2009 gets nasty: cuts through June of 38% (PFM) and 19% (SDY) but a 1% increase for VIG.

These big 2009 dividend cuts affect just the stocks in an investor's portfolio, not all of it. So in a typical allocation (where less than half the total income is from stocks and the rest is from high quality bonds or 'level income' bond ETFs such as BLV) the investor's income is steady or higher in 2008, then most likely down 5% to maybe 15% by June 2009.

Chopped livin' but not nearly the poundin'.

Background links:

https://retirementplans.vanguard.com/VGApp/pe/pubeducation/calculators/RetirementNestEggCalc.jsf

http://quicktake.morningstar.com/FundNet/TotalReturns.aspx?symbol=VBINX&country=USA

http://www.etfconnect.com/select/fundpages/etf_funds.asp?MFID=150190

http://www.etfconnect.com/select/fundpages/fixed_etf.asp?MFID=176475