Dividend Investing – A Perfect Fit For Aussie Early Retirees?

Dividend Investing

Regular readers will be aware of my love for dividend investing.

There’s nothing quite like making an investment, and in return, receiving an increasing sum of cash deposited straight into your bank account.  No hassles.  No bills.  And very little paperwork.  But it gets even better!

I believe dividend investing is a perfect fit for those of us aiming for early retirement.  This is especially true in Australia!  And today I’ll show you why.

 

Dividend Investing Doubts

Since I’ve started sharing my thoughts on investment openly, I’ve come across some folks who disagree with my approach.  And that’s perfectly OK.  In fact, it’s kinda good.  Often, we learn the most from the people who disagree with us!

Anyway, I want to delve deeper into why I prefer dividend investing over other retirement income strategies.  And clear up some issues I come across when people question it’s legitimacy.

When I first came out with this article, there were some concerns over my approach.  Namely, the figures I used for dividend returns and whether those numbers are sustainable.

To be clear, I was trying to highlight the advantage of dividend investing in Australia (partly due to franking credits), and how much income can be produced by investing in Aussie shares – using dividend yields at that time.

I wasn’t saying you should rely on a 6% ‘withdrawal’ rate.  I was saying that I think you can live off the dividend income from your portfolio (whatever that may be), while keeping some cash aside to smooth out any drops in dividends during retirement.

So I think some folk were quick to judge and wrote it off as irresponsible, without seeing the whole picture.  But it’s my error for not making my thinking clear enough!  Something I hope to remedy with this post.

Basically, I think due to the 4% rule studies which are mostly US based, some are convinced that living on returns higher than this, by definition, is unsustainable and a complete no-go.  I’m not saying those studies aren’t reliable.  They’re done by far smarter people than me!

But I am saying that there’s a few things that get overlooked and a blanket rule isn’t always fair (watch the pitchforks come out now!).

The US stockmarket and the Aussie stockmarket are different animals.  And dividend investing itself, is different too.  So let’s examine those differences, and see what we can learn.

 

US versus Australia

Firstly, I’m no market expert.  And I don’t have half the experience or knowledge that many people have.  But here’s what I see, when I look at the two markets.

The first thing to note, is the difference in dividend yields.  In recent times, the S&P 500 has traded on a dividend yield of around 2% (currently it’s 1.8%).  While the ASX 200 has traded on a dividend yield of around 4 – 4.5%, or 5 – 6% including franking.

In the US, the payout ratio is typically around 50% for the S&P 500.  But here in Australia, the payout ratio tends to be around 75% for the ASX 200.

Essentially, this means Aussie companies pay out more of their earnings as dividends to shareholders.  And therefore, US companies reinvest more earnings back into the business.

Why is this?

Well, it could be many reasons.  In the US, many companies are very innovative and growth focused.  Because of this, they retain as much cash as they can, to grow.

Also, they don’t have the franking credit system that we have, so paying dividends can more often lead to lower after-tax returns, once the shareholder has paid tax.

And in Australia, because of franking credits, companies are encouraged to pay out a higher level of dividends – since the franking credits are useless to the company, but very valuable to shareholders.

Here in Oz, we have a large amount of old, established and relatively slow growing businesses.  And quite often, these companies don’t have great growth prospects.  So they tend to pay out much of their earnings as dividends.

Sometimes they may see few growth opportunities, so they decide to do the smart thing and not burn cash chasing unlikely growth.  Instead, they sensibly pass most of the profits on to shareholders.

Other times, they may give in to dividend hungry shareholders, and end up paying out too much of their earnings.  This can eventually lead to a dividend cut.

It’s no surprise then…

Given the above points, it’s no shock that the US sharemarket trades on a higher Price/Earnings ratio (meaning it’s more expensive) than the ASX.  Because of lower payouts and higher growth expectations – people are willing to pay a higher price for a company/market that should grow earnings at a faster rate.

All else being equal, you would probably expect the companies with lower payouts to have better growth, and possibly better shareholder returns.  But, it’s not a given.

I’ve actually seen research showing that companies paying out higher levels of dividends, performed better.  This could be due to having an established and dominant market position, with less need for cash to grow.

Curiously, it could also be that the higher payouts force the company to be more disciplined with their capital, leading to better decisions and therefore higher returns.

Or, it could be that growth focused companies often spend without restraint because they’re chasing more growth and market-share in their industry (which may or may not pay off).

Either way, it doesn’t matter.  At the end of the day, it’s just not as simple as it seems.  High and low dividend payouts can be both good and bad.

 

Comparing Stockmarket Returns

Now, these returns are hypothetical.  Nobody really knows the future, let alone me!  But all we can do, is take the numbers we have today and make our own estimates for the future.  And for simplicity, we’ll just look at earnings and dividend growth.  We won’t consider share prices, for now.

Let’s take the US market first.  And we’ll assume that US companies can grow their earnings strongly into the future, due to the factors above.

So, a dividend yield for the S&P 500 of 2%.  Plus earnings growth of 6%.
Total return = 8%.  (Maybe a bit generous, but just go with it.)

And the ASX with a dividend yield of 4%.  Plus (slower) earnings growth of 3%.
Total return = 7%.

For some reason, let’s say we know the US market has a higher return for the foreseeable future.  Does that mean we should focus our investing there?  My answer is, not necessarily.

Dividend investors are looking to generate a strong, yet sustainable, growing income stream with their savings.  By investing in the ASX, which provides higher dividend income, we can create a larger level of income for our limited dollars.

Sure, if we each had $10 million to invest, different story.  Then, we’d have no trouble generating plenty of income from overseas shares.  But we’re not!  We’re working with much smaller sums than that!  And we’re trying to create a decent income with our savings.

 

In my opinion, the better choice for dividend investors wanting to retire early, is the Australian sharemarket.

 

So, in our example, we have a higher return from US stocks, because of the higher growth rate.  But we forgot something.  Franking credits!

Remember, when we’re investing in diversified LICs (like Argo, Milton, BKI or AFIC), our dividends come with the full benefit of franking credits.
Now our 4% dividend yield, becomes 5.7% grossed up.  Plus earnings growth of 3%.  Total return = 8.7%.

(To calculate a fully franked dividend, take the dividend and divide it by 0.7)

Honestly, we really do have a huge home-ground advantage by investing in our own backyard!

Overall, even if our market shows earnings growth of only 2% per year, versus 6% growth for the US – we end up with almost the same return (around 8%).

The difference is, our returns are mainly income focused, instead of growth focused.  There’s nothing wrong with that.  In fact, income-heavy returns are perfect for early retirees.

And we need not starve either!  This slow-growth scenario would likely still be enough for dividends to keep up with inflation.

(Side note – As a household, our spending is actually lower than it was 8 years ago when we joined forces.  And it seems to creep lower each year.  Maybe that won’t always be the case.  But it’s almost entirely within our control, which is important.)

So personally, we’re not worried about a super-slow-growth scenario.  It’s kind of a non-issue for us.  I would expect many frugal households experience this too.  With a little attention, it’s not hard to make sure your expenses grow slower than inflation.

Franking is mostly ignored in market and return comparisons.  And since it’s not a tax deduction, but a tax credit (real cash), this is plain nuts!  Sure, this brings it’s own risk that it could be taken away.

But I’m not sure it’s any more of a risk than anything else – personal/company tax rates, economic conditions, demographics etc.

And besides, even without it, we still have more attractive income returns and likely competitive total returns – as I outlined above.

 

Is Australia Boring?

So depending on how you look at it, Australia is perhaps a boring place for share investing.  Since the US market has been racing along for close to 10 years now, many Aussies are looking abroad to invest.  And it’s not hard to see why.

In the US, there are some of the most exciting and innovative companies in the world.  But because of this, their share prices are flying high and many are double or triple what they were just a few years ago.

In comparison, Australia has been slowly and steadily inching back towards it’s pre-GFC high.  Our market has certainly been boring in comparison to the US, no doubt.  But it should be noted, dividend investors have still been receiving a strong level of income, which has been rising since the GFC low.

My thoughts on this are split.  If you’re focused on getting the highest total return, then you will have been much better served investing in the S&P 500 (for the last 10 years at least).  But if you’re following a dividend investing approach for solid income, you’re probably still better off investing in the Aussie market.

 

The dividend yield is double, plus we get franking credits, which makes the gross yield currently about triple the US!

 

To be honest, which market outperforms in the next 10 years is anyone’s guess.

Quite often, one market will perform better for a decade or so.  Then, in the next decade, the other country’s market will do better.

At the end of the day, it’s not even about which market outperforms.  What it’s really about, is which type of investment is going to meet your personal needs/goals.

For those of us passionate about early retirement, we need a strong and steadily growing income stream.  So our dividend investing is better focused on the market best suited to provide that – the ASX.

 

Australia’s Outlook?

Here’s my simpleton take on things – Australia appears set to be one of the higher-growth developed countries.  We have high population growth, relative to many other nations.  And this bodes well for company earnings (more customers) and therefore dividends into the future.

Now it’s true, the ASX is a concentrated market with over 35% financials and the top 10 companies making up around 50% of the entire market’s value.  But we can reduce this risk by also investing in LICs that focus on small/mid sized companies.  I spoke about this here (I’ll review some of these LICs in the future).

This way, we get a much more diverse spread of companies, which operate in different sectors, while still generating strong dividend income.  And by increasing our diversification this way, we benefit from the broad growth in the Australian economy.

But obviously, if you feel Australia is going down the crapper, this won’t matter.  And investing overseas makes a lot more sense!

 

Cautious Optimism

I’m optimistic about the future.  But I also don’t want to get carried away and expect too much from my investments.  While my figures seem too generous to some, we have personally built in some safety margins.

Firstly, we have more savings (equity) than required to meet our income needs.  Next, we also keep a decent amount in cash (around 1-2 years living expenses) to smooth any times dividends are reduced.

We’d also look to spend less in that situation, or create some part-time income to make up the difference.  And our expenses are likely to grow slower than inflation, giving a further safety margin if dividends grow very slowly for a long time.

There are many types of backup plans you can put in place (future article planned).

 

Bogle’s Calculator

It’s worth noting, estimating future investment returns need not be complicated.

Even John Bogle himself (founder of Vanguard) uses a very simple equation when he looks at the markets.  He says in this interview, that a reasonable expectation of future returns is…

Today’s dividend yield, plus earnings growth – what he calls ‘fundamental return’.
And then the change in valuations (Price/Earnings ratio) higher or lower – which Bogle calls ‘speculative return’.

It’s important to realise that this change in valuations, is nothing to do with the earnings of the companies.  Therefore, also has nothing to do with the dividends paid out by those companies.

It’s merely the share prices people are willing to pay.  That’s why Bogle calls this part of the equation ‘speculative return’.

 

Dividend investing for early retirement is far more reliable, because it’s based on fundamentals (dividends plus earnings growth), and not reliant on the speculative side of things (fluctuating prices).

 

Who cares what people are willing to pay for shares tomorrow or next year?  What we care about is the economy and company earnings, which is where our dividends come from.

Funnily enough, he’s also said – we should be investing for income, focusing on the dividends in retirement and not stock prices!  It’s refreshing to see such a simple thought process, for such a titan of the investment industry.

 

Keep It Simple

So it seems to me, dividend investing is a fairly sensible way to go about retiring on shares.  And the figures we’ve used above, also seems to be fairly realistic.

I’ve noticed some people get stuck in the weeds trying to calculate future returns.  And agonising over formulas and charts to see how much of their portfolio they can live off.

To me, it’s simple.  Provided we’re invested in quality LICs or Index Funds, where the dividend income can reasonably be expected to rise (at least) with inflation over time – we can simply use the dividends to live on.  And also keep some cash to cover any bumps in the road.

The less flexible you are with your lifestyle, spending, ability to work – the more extra cash you’ll likely need.

 

Dividend Investing meets Early Retirement

There’s another way that dividend investing fits snugly into our financial independence plan.  And it’s another perk of the tax system.

Currently in Australia, we have a tax-free threshold for individuals of $18,200, plus a ‘Low Income Tax Offset’.  So it works out, we can actually earn $20,500 of income per year, and not be up for a single dollar of tax!  (Check this calculator to see for yourself)

What this means is, a couple can earn $41,000 per year tax-free.  Effectively, our own retirement spending can be funded from $700k of Aussie LICs that are yielding 4% fully franked (5.7% gross).  And we’ll pay absolutely no tax on this income.

Above this level of income, regular tax rates start to apply.  But still, it’s a pretty generous system.  Maybe the government feels sorry for us living on a low income 😉

Dividend investing in Australia, can potentially allow you to retire on a juicy income stream which is very low tax, or even tax-free!

I’m not saying it’s the best strategy in the world.  But I am saying, it makes a lot of sense for our situation (and likely many others too).  Most importantly, there’s no need to sell-off shares for income during retirement – something I’m not a fan of, as I outlined in this article.

 

Final Thoughts

Dividend investing may not be for you.  And that’s OK.  We all need to choose an approach we’re comfortable with.

But I hope this makes my thinking more clear.  And why I favour dividend investing – which is really just investing, but with a dividend focus.  I don’t see much of this discussion by other bloggers, so I wanted to share my thoughts.

Maybe it’s just me, but I feel as though owning 100+ different businesses in Australia – through LICs or an Index Fund is reasonably diversified.  And with much higher dividend yields here, plus the benefit of franking credits, the income is just too good to pass up.

Then, we can also add international shares if we want to reduce our risk and diversify our funds further.  Personally, we’ll be doing this later, once our Aussie portfolio is fully established and covering all our bills.  I see international shares as a ‘nice to have’, not a ‘must have’.

Here’s one way to think about it:

Focus on building the required dividend income for financial independence first, through Aussie shares.  Then with any additional funds, look to add international shares for dividend growth, and to further diversify.

It may seem flawed or biased to some, that’s fair enough.  But putting this all together, I think dividend investing is perfect for Aussies shooting for financial independence!

 

22 comments

  1. What a cracker of an article – thank you. I get so sick and tired of folks chewing my ear off about my love of dividend investing (even though dividend investing is only 50% of my portfolio, the other half being VGS and VGAD).

    VHY announced its quarterly dividends the other day – you simply can’t beat the feeling of dividends being announced then paid. Argo, AFIC and Milton will not be too far away either ….can’t wait.

    I treat Ozzie dividend investing the same way US treats bonds. LIC’s 100% franked are my ‘bonds’.

    Phil

    1. Thanks Phil!

      Nice – you have a much more well rounded portfolio than me at the moment. But we’re quite income hungry at this stage.
      VGS will be our index of choice too, when the time comes. I just see dividend investing as a different approach to the sell-down method. It’s like some folks buy property for growth, others for cashflow. It’s a different focus.

      Haha I share your excitement! Looking forward to the reports and not long after, the dividends 🙂

        1. I actually used to hold it, but don’t anymore. In theory, it sounded really attractive. But when I was holding it, it ended up having large positions in stocks like BHP and RIO because of their huge ‘forecast’ yields at the time but were becoming obviously unsustainable (BHP’s payout ratio was forecast to be something like 250%). The index didn’t kick those two stocks out until their dividend cut, which sucked. Also, I remember receiving really lumpy distributions – a bunch of capital gains, due to them changing holdings to the new ‘forecast high yield’ stocks, which wasn’t ideal.

          The performance seems to have been pretty decent, but I ended up deciding I just don’t like how the product works in practice. Have looked at it since a few times, and the top 10 holdings tends to change a fair bit, implying turnover and capital gains paid out. I’ve decided I prefer the predictable nature of the older LICs with dividend smoothing. Also if there’s capital gains from sales they can retain it due to the ‘company’ structure, or pay it out as a special dividend where we get the CGT deduction as if we owned it ourselves.

          Overall, I like the company structure better and the predictable dividends. I’d be happy to hold the plain vanilla index funds though like VAS or VGS, despite lumpy distributions and some cap gains paid out.

  2. Great article – very detailed. I love dividends and the franking system. If you are looking at achieving FIRE, this can be combined with super contributions to reduce tax prior to age 60 and then drawing down tax free after 60 from super or your own SMSF.

    1. Cheers, and appreciate the tip.
      We’ll look at strategies like that a bit later. Given I’ve just retired, yet still have roughly 31 years until super access, I’m not looking at throwing extra cash into super just yet! But later, we will definitely look to use it to full effect.

  3. Question: I don’t fully understand how franking credits work, so I would like to write a scenario and I hope you can help.

    I earn $150,000 a year as normal income (not retired yet)

    I buy a share worth $X which pays me a dividend of $10 per a given tax year fully franked.

    How much tax do I pay on the dividend?

    My top tax rate is 37%, that means that the $10 that I got, i’ll have to pay taxes of 37% on it meaning $3.7. Since, its fully franked meaning that the company already paid $3 tax on this, so I guess my tax will be reduced by this to $.7.

    So, I have to pay a tax of 7% on my dividends? Is that correct.

    Now if I own US shares worth $1000,000 which has a dividend yield of 2% (20k), I pay a tax of $7400.
    Same with Aussie shares, if it has dividends of 4% (40k), I pay taxes of ($2800) if its fully franked. If its 50% franked, then i’ll pay 22% tax (15% which company didn’t pay and 7% extra from myself) i.e. $8800.

    Is this line of thinking factually correct or am I missing something? It seems like it depends heavily on your income if more dividend including franking credits is good for you. Also, it depends on how much franking credit is provided by the stocks you own. Do you know some place where we can find stocks (or their packages, such as index funds or LICs) with high dividend and good franking credits?

    1. I’m not sure about the franking, but as for finding index funds and LICs I’ve found etfwatch.com.au fairly helpful.

    2. Yep, sounds like you’re on the right track.
      If 30% tax has been paid – you pay the difference. Or, you’re refunded the difference if you’re tax rate is less than 30%.

      You’re right about thinking about it all in percentage terms, that’s what I do. And when it’s all in the same tax bracket, that’s correct.

      But in that scenario, you creep into the higher bracket (income goes over 180k), so there’s likely a little extra tax to pay.

      Investing for income is more effective with a lower tax rate of course. But eventually we want to live on the investments in retirement (usually much lower tax brackets) so we want that same good income to be there. We don’t want to be switching investments, say from growth first to income later.

      There are other options available to high income earners such as Bonus Share Plans, which I spoke about in this post. Essentially, you can receive extra shares instead of dividends, meaning no income needs to be declares. You also don’t get franking credits thought – so effectively anyone on a higher tax rate than 30% would benefit from that. So if the dividend is 4%, you receive that in shares instead of cash. The catch is if you sell, your cost base is basically reduced because you have shares which didn’t cost anything and it lowers your average price – therefore you’d pay a bit extra capital gains tax. These Bonus Share Plans are only offered by AFIC and Whitefield (both good quality, long term focused LICS). It’s a good option as it can mean higher after-tax returns for high income earners wanting to accumulate shares over a long period – better suited to those with no intention of selling! Worth taking a look at though.

      Other than that, there’s plenty of good LICs which offer yields around 5.5-6% gross – many I spoke of in this article. There’s also others such as Platinum Capital (PMC) and WAM Research (WAX) which are a bit different but offer higher yields. Vanguard has a high yield dividend fund (VHY) also. Do your own research here as I’m not an expert or advisor. And it’s important to note that yield isn’t everything. We need our income to grow over time also. Very high yields often come with high risk or little to no growth

  4. Phew that was a long post. Great effort young fella.

    Terrible things those dividends. I have to keep finding things to spend them on. Fortunately my favourite thing which brings out the shopaholic in me is buying more dividend paying LICs:-). But then I have even more dividends to spend. So round and round we go. All very stressful.

    Must admit we mostly secured our income with Aussie dividend payers first before really doing anything much about International exposure. The only LIC that we’ve held since early on with an International focus is PMC. And that was because it’s unusual in paying quite a decent fully franked dividend. Then again there wasn’t much choice either back then. However PMC’s still not as a reliable dividend payer as the ASX focused older style LICs.

    The total return index types tend to be critical of dividends. But I just ignore them. I really enjoy the dividends consistently rolling into our accounts with no effort on our part. No having to decide what to sell or sleepless nights as a result of capital volatility when needing to convert capital to income for living expenses.. Dividends, pure bliss.

    Cheers

    1. Thanks Austing.

      That does sound stressful! If you’re having trouble with those dividends, pass them on, I’ll unburden you 😉

      Appreciate you sharing your story. That approach makes sense to me. I do like PMC but the reliability of it’s dividend is a bit of a concern (not a great history). I’d prefer a lower, but more stable, steadily increasing dividend. Do you know what happened historically and if it’s more reliable now?

      I’ve just a different approach I guess, no right or wrong – but yes they can be pretty dismissive of dividends. Personally, I think it makes way more sense, no matter what country you’re investing in. The income approach is just much simpler, less decisions to be made and less to think about. Maybe we’re just lazy!

      1. Re PMC the dividend was less reliable prior to 2010. Since then changes to company accounting rules relating to the solvency test make it much easier for the “trading” LICs to pay dividends especially during difficult market times.

        PMC was a compromise to us earlier on in that it at least paid a decent dividend compared to other International focused LICs. Probably in your case continuing to focus on Aussie LICs gives you the reliable income you need now. I mostly bought into PMC and the like when they are great value unlike the older style LICs which involved more steady Accumulation.

        Hope that helps.

        1. Thanks mate, it does help.

          Their outperformance of the International index after fees is very impressive over the 20+ years they’ve been running. I like that they have an all-world exposure including Asia. It’s on the watchlist for now.

          1. Yeah I Iike PMC for the strong Asian tilt (but not restricted to Asia only) where I think an active Mgr can add value. It’s a good compliment to VGS large / mid cap developed International where active Mgrs struggle badly to add value.

          2. That’s a good point. They’ve definitely done that. And it does seem like a nice add-on to VGS. VGE also looks quite suitable, albeit with lower income than PMC.

  5. i will take a proper time to diggest the whole info but i really like the approach. in the end doesn t matter which path you choose as long as it suits your needs and investment philosophy.

    one thing that has left me out of LICs and its dividend (i do have some in my portfolio) is the lack of diversity. at present australia has got the highest debt pp in the world.

    as long as the strategy takes into account exit points just in case you ll be safe. so someone who has a 30 year plan it is ok, but for us who want to RE its good to have a back up plan or be ready to work more years to sustain a crash. inevitable in my opinion.

    1. Exactly. Everyone needs to find something they feel comfortable with.

      Australia’s debt is a concern to many. It’s not a great thing I guess, but the numbers I’ve seen show that the amount of interest we’re currently paying as a portion of our incomes is very low – although it’s increasing.

      This is where international shares come in. For many people, they don’t want to take the extra risk having all their investments in one country. It’s a good idea, and part of our long term plans.

      I don’t agree with creating exit points, if you mean selling? The whole point of long term income focused investing is for us to accumulate over our lifetimes. Whether it’s index funds or LICs, the goal is to hold for the foreseeable future. Exiting the markets is almost always a horrible idea for anyone’s long term wealth, and I don’t expect that to change.

      You’re right though, backup plans are a must! No plan is bulletproof!

  6. Hey SMA,

    Excellent article and thanks for detailing your thoughts and your process in how you did it. I’d like to think we are following in your footsteps, except we’re 10 years behind 🙂

    As you have excellently outlined, the Australian LICs can perfectly set up a retiree with the higher yields and as long as the income slowly grows faster than inflation then everything works out. Just hold and let the dividends roll in.

    Australian LICs are wonderful setups, but my only ‘concern’ would be that the index-similar LICs rely on the big stocks and the Australian economy in general to do well. It’s been 25 years since Australia’s last technical recession, so it will be telling what happens what happens to those LICs (and their portfolios) when a recession next hits. We are shareholders in several LICs, but only ones that have shown they can beat the market (after fees) plus pay out a growing dividend, I’m sure you own a lot of those as well. So far, we have avoided the big LICs. Just my own thoughts on why we have a very similar end-goal but our share holdings are perhaps a bit different 🙂

    Mr DDU

    1. Thanks Mr DDU!

      I’m sure you guys will do just fine – it’s good to see your portfolio steadily growing 🙂

      You raise a good point, the old-school LICs are reliant on the largest companies. There will be surely be drops in dividends in a downturn, so we need to plan for that. I wouldn’t feel entirely comfortable relying on just those as a portfolio, which is why I think it’s good to hold some other LICs which focus on mid/small size companies too. That way our income stream is coming from a wider blend of companies.

      I plan to share a hypothetical portfolio at some stage, to give an example of improving diversification while still being Oz only. If anyone wants to go one step further and add International as well, that’s likely a good move, although will dilute their income.

      Appreciate you sharing your thoughts here!

  7. Great write up, quality stuff. I have yet or understand clearly myself, a comparison of tax effectiveness, i.e. your chosen strategy vs a total return one , in the Australian landscape, at lowest tax rate for someone RE, pre-super.

    For example you can withdraw $41,000 tax free via income splitting over 2 people, with $700,000 worth of AFIC. Nice, simple, solid, clear.

    If you then want to withdraw the $41,000 – What would $700,000 of VDHG returning 10% for example get you. Mix of spending the dividends and selling portions to reach $41k, what would the cap gains tax be? Assumed say the portion you had to sell had grown 10% , for example.

    Or, what would $700,000 of VGS last year returning say 13%, that you then again assumed say the portion you had to sell had grown 10% , for example. You then pay cap gains tax at 50% on the portion you sold to make up the dividend balance…..

    Then what would be the balances of the three funds end of year after income paid out, tax paid ( none in the case of your LIC strategy) , and any sales of stocks, plus growth of all three. Interested in any thoughts on the net result. I know the assumptions have variables but I assume you have done the numbers on these before going down the LIC path?

    It hurts my head trying to figure this out.

    Any takers? Thanks!

    1. Thanks, glad you enjoyed it.

      Wow, that’s a tough one!

      So this is where the two strategies kind of part ways (the indexing withdrawal vs living on income). With the dividend approach, there is literally nothing to be done. The cash just comes in, no withdrawals, no selling, no cap gains.

      I’m not sure there’s an easy way to calculate that scenario, because it would depend how long the funds held on to the underlying stocks and how much cap gain was associated with each holding. Also there’s rebalancing that occurs which adds another layer of complexity in trying to figure this out. I’m just not sure I can answer it and I don’t think it’s that simple.

      This is part of the reason I prefer the dividend income approach. There’s no rebalancing, no selling, no cap gains taxes. Nothing to do and no decisions to make. Just income coming in. The behavioural thing was another reason for my choosing dividends to live on. I don’t have to look at the market, if stocks go down it doesn’t matter.

      So even if the net after tax result is better for the total return approach, I prefer the pure simplicity of dividends.
      Sorry, I know this wasn’t the answer you wanted! But it hurts my head too, and I put it safely in the too-hard basket 🙂

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