Why 'I'll Just Sell A Few Shares When I Need Cash' Doesn't Work

by: Robert Allan Schwartz

In the article The Misplaced Mania Over Dividend-Paying Stocks by Arnold Landy, commenter "varan" asked:

"1. Stock A grows with a CAGR of 8% (obviously the yearly return fluctuates) over a 30 year period with no dividend. The owner of the stock takes out 4% every year, irrespective of what a particular year's return is. The number of shares that he owns is high enough so that the transaction cost in selling 4% every year is minimal.

2. Stock B grows with a CAGR of 4% (obviously the yearly return fluctuates) over a 30 year period and the dividend is 4% which the owner has as income.
Question: What is the difference between the two scenarios for the investor?"

varan is asking if "I'll just sell a few shares when I need cash" is the same as receiving a dividend.

Is it?

Let's ignore the effects of taxes, the time value of money, brokerage costs, etc. as they will not affect the conclusion. Let's pretend we live in a magical world where stocks go up by 8% every year.

Suppose you own 5,000 shares of stock A. The share price is currently $100. At the beginning of each year, you sell 4% of the market value of your shares. The following chart shows what happens over 30 years:

date # shares owned $ / share market value # shares sold $ received # shares owned
Jan 1 year 1 5000.0000 $100.00 $500,000.00 200.0000 $20,000.00 4800.0000
Jan 1 year 2 4800.0000 $108.00 $518,400.00 192.0000 $20,736.00 4608.0000
Jan 1 year 3 4608.0000 $116.64 $537,477.12 184.3200 $21,499.08 4423.6800
Jan 1 year 4 4423.6800 $125.97 $557,256.28 176.9472 $22,290.25 4246.7328
Jan 1 year 5 4246.7328 $136.05 $577,763.31 169.8693 $23,110.53 4076.8635
Jan 1 year 6 4076.8635 $146.93 $599,025.00 163.0745 $23,961.00 3913.7889
Jan 1 year 7 3913.7889 $158.69 $621,069.12 156.5516 $24,842.76 3757.2374
Jan 1 year 8 3757.2374 $171.38 $643,924.46 150.2895 $25,756.98 3606.9479
Jan 1 year 9 3606.9479 $185.09 $667,620.88 144.2779 $26,704.84 3462.6700
Jan 1 year 10 3462.6700 $199.90 $692,189.33 138.5068 $27,687.57 3324.1632
Jan 1 year 11 3324.1632 $215.89 $717,661.90 132.9665 $28,706.48 3191.1967
Jan 1 year 12 3191.1967 $233.16 $744,071.86 127.6479 $29,762.87 3063.5488
Jan 1 year 13 3063.5488 $251.82 $771,453.70 122.5420 $30,858.15 2941.0068
Jan 1 year 14 2941.0068 $271.96 $799,843.20 117.6403 $31,993.73 2823.3666
Jan 1 year 15 2823.3666 $293.72 $829,277.43 112.9347 $33,171.10 2710.4319
Jan 1 year 16 2710.4319 $317.22 $859,794.84 108.4173 $34,391.79 2602.0146
Jan 1 year 17 2602.0146 $342.59 $891,435.29 104.0806 $35,657.41 2497.9340
Jan 1 year 18 2497.9340 $370.00 $924,240.10 99.9174 $36,969.60 2398.0167
Jan 1 year 19 2398.0167 $399.60 $958,252.14 95.9207 $38,330.09 2302.0960
Jan 1 year 20 2302.0960 $431.57 $993,515.82 92.0838 $39,740.63 2210.0122
Jan 1 year 21 2210.0122 $466.10 $1,030,077.20 88.4005 $41,203.09 2121.6117
Jan 1 year 22 2121.6117 $503.38 $1,067,984.04 84.8645 $42,719.36 2036.7472
Jan 1 year 23 2036.7472 $543.65 $1,107,285.85 81.4699 $44,291.43 1955.2773
Jan 1 year 24 1955.2773 $587.15 $1,148,033.97 78.2111 $45,921.36 1877.0662
Jan 1 year 25 1877.0662 $634.12 $1,190,281.62 75.0826 $47,611.26 1801.9836
Jan 1 year 26 1801.9836 $684.85 $1,234,083.99 72.0793 $49,363.36 1729.9042
Jan 1 year 27 1729.9042 $739.64 $1,279,498.28 69.1962 $51,179.93 1660.7081
Jan 1 year 28 1660.7081 $798.81 $1,326,583.82 66.4283 $53,063.35 1594.2797
Jan 1 year 29 1594.2797 $862.71 $1,375,402.10 63.7712 $55,016.08 1530.5086
Jan 1 year 30 1530.5086 $931.73 $1,426,016.90 61.2203 $57,040.68 1469.2882
Click to enlarge

It certainly appears as though "I'll just sell a few shares when I need cash" works, i.e. provides a stream of income that rises enough to counteract inflation.

Let's return to the real world, where stocks do not go up by 8% every year.

Suppose you own 5,000 shares of stock A. The share price is currently $100. At the beginning of each year, you sell 4% of the market value of your shares. Suppose the share price goes up and down by the same percentage as the S&P 500 [historical prices from Yahoo! Finance, symbol "S&P 500 (^GSPC) - SNP"]. Suppose we begin on January 1, 1983. The following chart shows what happens over 30 years:

date # shares owned $ / share market value # shares sold $ received # shares owned s&p 500 % change inflation
Jan 1 1983 5000.0000 $100.00 $500,000.00 200.0000 $20,000.00 4800.0000 $138.34
Jan 1 1984 4800.0000 $118.58 $569,171.61 192.0000 $22,766.86 4608.0000 $164.04 18.58 3.22
Jan 1 1985 4608.0000 $119.54 $550,834.87 184.3200 $22,033.39 4423.6800 $165.37 0.81 4.30
Jan 1 1986 4423.6800 $151.50 $670,203.19 176.9472 $26,808.13 4246.7328 $209.59 26.74 3.55
Jan 1 1987 4246.7328 $178.15 $756,547.13 169.8693 $30,261.89 4076.8635 $246.45 17.59 1.91
Jan 1 1988 4076.8635 $185.01 $754,252.16 163.0745 $30,170.09 3913.7889 $255.94 3.85 3.66
Jan 1 1989 3913.7889 $199.01 $778,881.91 156.5516 $31,155.28 3757.2374 $275.31 7.57 4.08
Jan 1 1990 3757.2374 $260.00 $976,898.02 150.2895 $39,075.92 3606.9479 $359.69 30.65 4.83
Jan 1 1991 3606.9479 $235.98 $851,155.23 144.2779 $34,046.21 3462.6700 $326.45 (9.24) 5.39
Jan 1 1992 3462.6700 $301.62 $1,044,407.75 138.5068 $41,776.31 3324.1632 $417.26 27.82 4.25
Jan 1 1993 3324.1632 $314.72 $1,046,171.87 132.9665 $41,846.87 3191.1967 $435.38 4.34 3.03
Jan 1 1994 3191.1967 $336.45 $1,073,666.74 127.6479 $42,946.67 3063.5488 $465.44 6.90 2.96
Jan 1 1995 3063.5488 $331.87 $1,016,702.24 122.5420 $40,668.09 2941.0068 $459.11 (1.36) 2.61
Jan 1 1996 2941.0068 $448.70 $1,319,626.41 117.6403 $52,785.06 2823.3666 $620.73 35.20 2.81
Jan 1 1997 2823.3666 $532.75 $1,504,155.99 112.9347 $60,166.24 2710.4319 $737.01 18.73 2.93
Jan 1 1998 2710.4319 $704.81 $1,910,350.96 108.4173 $76,414.04 2602.0146 $975.04 32.30 2.34
Jan 1 1999 2602.0146 $887.74 $2,309,913.37 104.0806 $92,396.53 2497.9340 $1,228.10 25.95 1.55
Jan 1 2000 2497.9340 $1,051.92 $2,627,615.71 99.9174 $105,104.63 2398.0167 $1,455.22 18.49 2.19
Jan 1 2001 2398.0167 $927.62 $2,224,449.08 95.9207 $88,977.96 2302.0960 $1,283.27 (11.82) 3.38
Jan 1 2002 2302.0960 $834.66 $1,921,469.71 92.0838 $76,858.79 2210.0122 $1,154.67 (10.02) 2.83
Jan 1 2003 2210.0122 $657.10 $1,452,195.58 88.4005 $58,087.82 2121.6117 $909.03 (21.27) 1.59
Jan 1 2004 2121.6117 $801.27 $1,699,988.52 84.8645 $67,999.54 2036.7472 $1,108.48 21.94 2.27
Jan 1 2005 2036.7472 $868.93 $1,769,794.05 81.4699 $70,791.76 1955.2773 $1,202.08 8.44 2.68
Jan 1 2006 1955.2773 $917.16 $1,793,303.36 78.2111 $71,732.13 1877.0662 $1,268.80 5.55 3.39
Jan 1 2007 1877.0662 $1,024.00 $1,922,113.65 75.0826 $76,884.55 1801.9836 $1,416.60 11.65 3.24
Jan 1 2008 1801.9836 $1,046.09 $1,885,035.83 72.0793 $75,401.43 1729.9042 $1,447.16 2.16 2.85
Jan 1 2009 1729.9042 $673.56 $1,165,190.67 69.1962 $46,607.63 1660.7081 $931.80 (35.61) 3.85
Jan 1 2010 1660.7081 $818.99 $1,360,102.38 66.4283 $54,404.10 1594.2797 $1,132.99 21.59 -0.34
Jan 1 2011 1594.2797 $919.38 $1,465,748.58 63.7712 $58,629.94 1530.5086 $1,271.87 12.26 1.64
Jan 1 2012 1530.5086 $923.13 $1,412,860.53 61.2203 $56,514.42 1469.2882 $1,277.06 0.41 3.16
Click to enlarge

There were 3 years (1985, 2008, 2012) when your income went up (+0.81%, +2.16%, +0.41% respectively), but not by enough to overcome inflation [inflation figures taken from www.inflationdata.com/inflation/inflatio...].

There were 6 years (1991, 1995, 2001, 2002, 2003, 2009) when your income dropped (-9.24%, -1.36%, -11.82%, -10.02%, -21.27%, -35.61% respectively). Your income was lower in 2009 than it was in every year from 1996 onward.

You lost purchasing power and/or income in 9 out of 30 years.

If your goal is to provide a stream of income that rises enough to counteract inflation, then you did not achieve your goal.

You might think about (A) selling fewer shares when the share price is higher and selling more shares when the share price is lower, or (B) banking "excess" income in years when you have it, for years when you need it, but this is not enough - what if you retired on 1/1/2001 or 1/1/2009, and for your first year (or three) the share price declined?

Further Reading

Anyone considering selling assets to fund retirement should read the following articles by David Van Knapp:

Conclusion

Anyone planning for a reliable income stream during retirement, that grows faster than inflation, should avoid the "I'll Just Sell A Few Shares When I Need Cash" fallacy. It doesn't work.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.