Safe Retirement Withdrawals From A Dividend Fund Portfolio

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Includes: CL, CVX, DON, DTN, JNJ, KO, MCD, MMM, PEP, PG, SHY, T, TLT, WMT
by: Toma Hentea

Summary

A portfolio of ten dividend aristocrats allowed a safe annual withdrawal rate of 8% over a nine year period from October 2006 to July 2015.

A portfolio of dividend ETFs combined with a long term bond and a short term bond ETF allowed a safe annual withdrawal rate of 14% over the same time.

At a withdrawal rate of 5%, the ETF portfolio almost tripled the capital in nine years.

This article is written in response to many requests from readers of my latest published article. The readers were interested to find out how the two portfolios discussed in that article would behave under periodic money withdrawal typical of retirement accounts.

Although I recommend that new readers go and check that article, I will repeat the things that are crucial in understanding what I m talking about here.

The first portfolio is a strictly stock portfolio containing the following ten dividend aristocrats: MCD, MMM, CL, KO, CVX, WMT, JNJ, PEP, PG and T. This list was the subject of many highly celebrated articles written by DGI proponents. We assume that $100,000 was invested equally among the ten stocks on October 1, 2006. No changes were done to the portfolio. All the dividends were reinvested in the stocks producing them.

The second portfolio contains two dividend ETFs, DON and DTN. The first one invests in mid cap dividend growing stocks, the second in large value high yield stocks. We also include two bond ETFs, SHY for short term bonds and TLT for long term bonds. The portfolio is managed based on quarterly asset reallocation as dictated by a mean-covariance optimization algorithm. On the first day of each quarter we estimate the covariance matrix of the returns over the previous 65 trading days, roughly corresponding to the latest three-month period. Based on the means and volatilities of the returns, as well as the correlation between the asset returns, the algorithm determines the optimal allocation of the assets that would have produced the highest total return without exceeding a given level of volatility of the returns. This allocation is maintained until the first trading day of the next quarter when a new allocation is determined.

The data for the study were downloaded from Yahoo Finance on the Historical Prices menu for all the tickers mentioned above. We use daily price data from July 2006 to July 2015, adjusted for dividend payments.

We simulated the two portfolios using historical price data between September 16, 2006 and July 31, 2015. We performed simulations under the following two scenarios:

  1. No withdrawals of any money are made. We call this % withdrawal rate. All the dividends are reinvested.
  2. At the beginning of each quarter a fixed inflation adjusted amount of money is withdrawn from the account. At the start, on October 1, 2006, 1.25% of the initial capital, i.e. $1,250 is withdrawn. Subsequently, the amount withdrawn is increased to account for inflation at a 2% annual rate. By doing this adjustment, the amount withdrawn on July 1, 2015 was $1,496. We call this scenario 5% withdrawal rate. Most of the time the withdrawal is made out of dividends and the surplus of dividends is reinvested by buying additional shares of stock, but when dividends do not suffice to cover the withdrawal, shares of stocks are being sold.

In table 1 we show the performance of the portfolios under the 0% withdrawal rate. We list the total dollar return, the compound average growth rate (CAGR%), the maximum drawdown (maxDD%), the annual volatility (VOL%), the Sharpe ratio and the Sortino ratio.

Table 1. Performance of portfolios with 0% withdrawals.

Total return

CAGR

maxDD

VOL

Sharpe

Sortino

BH Aristocrats

122.56%

9.46%

-31.67%

15.46%

0.61

0.79

Adaptive Allocation

288.84%

16.60%

-12.11%

13.09%

1.27

1.75

As can be seen in table 1, the ETF portfolio with adaptive allocation outperformed the buy-and-hold dividend aristocrats portfolio on all criteria. It generated higher returns at lower risk.

In table 2 we give the results for the 5% annual withdrawal scenario. Here we list the total excess return after the 5% annual withdrawals.

Table 2. Performance of portfolios with 5% annual withdrawals

Total excess return

CAGR

maxDD

VOL

Sharpe

Sortino

BH Aristocrats

47.85%

4.52%

-35.57%

15.88%

0.29

0.37

Adaptive Allocation

187.87%

12.70%

-12.72%

13.14%

0.97

1.34

Both portfolios were capable of delivering an annual 5% withdrawal rate and still end up with sizable gains. The buy-and-hold dividend aristocrats portfolio managed to accumulate a 47.85% increase in equity, while the adaptive allocation dividend ETF portfolio gained 187.87%.

We performed additional simulations to determine what would have been the highest annual withdrawal rate that would still result is an equity no less than the initial capital. The buy-and-hold dividend aristocrats portfolio with an annual withdrawal rate of 8% achieves a final equity of $103,020. The adaptive allocation ETF portfolio with an annual withdrawal rate of 14% ends up with $106,040.

In Figures 1 and 2 we show the equity curves of the portfolios.

Figure 1. Equity curves of the buy-and-hold dividend aristocrats portfolios.

Source: This chart is based on EXCEL calculations using the adjusted daily closing share prices of securities.

Figure 2. Equity curves of the dividend ETFs portfolio with adaptive allocation.

Source: This chart is based on EXCEL calculations using the adjusted daily closing share prices of securities.

Conclusion

An example of a buy-and-hold portfolio of ten dividend aristocrats was shown to be robust and allow a safe annual withdrawal rate of up to 8% over the most recent nine years that comprised a severe bear market followed by a strong bull market. Over the same period, an adaptive allocation portfolio of two dividend ETFs together with two bond funds was able to withstand a huge 14% annual withdrawal rate. Of course, past performance does not guarantee future results. Nevertheless, this study gives a benchmark that future performance may be compared against.

Additional disclosure: The article was written for educational purposes and should not be considered as specific investment advice.

Disclosure: I am/we are long SHY.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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