Tuesday, May 17, 2011

How Much Can I Spend?

One of the most important questions we help answer for our clients as they near retirement is how much they are able to spend from their investment portfolio each year.  A common approach to dealing with this issue to determine how much interest and dividends are being paid into the portfolio and then to spend that amount each year.  We have always felt that this is a somewhat flawed approach. Rather than focusing on yield, we prefer to focus on the total investment return of a portfolio and then to calculate a reasonable, sustainable withdrawal rate.

Well, here is an academic's answer to the same question.  The video below comes from the Fama/French Forum. Here is the introduction from that site:

"Should retirees limit their spending to the interest and dividends they receive? Ken French says investors should be indifferent to how they raise cash, whether through dividends and interest, or through the sale of shares--a method Merton Miller called "homemade dividends." Despite the economic logic, some investors focus on dividends and interest. While this approach may encourage disciplined spending, Ken explains that it also can distort one's investment approach--for example, when investors choose dividend-paying stocks over broad diversification, or chase higher yields by holding riskier bonds. In an effort to get more, they actually lose."