The Yield Illusion Follow-Up (SWR Series Part 30)

Welcome to a new installment of the Safe Withdrawal Series! The last post on the Yield Illusion (Part 29) was definitely a discussion starter! 140 comments and counting! Just as a quick recap, fellow bloggers at Millenial Revolution claim that the solution to Sequence Risk is to simply invest in a portfolio with a high dividend yield. Use the dividend income to pay for your retirement budget, sit back and relax until the market recovers (it always does, right?!) and, boo-yah, we’ve solved the whole Sequence Risk issue! Right? Wrong! As I showed in my last post, it’s not that simple. The Yield Shield would have been an unmitigated failure if applied during and after the 2008/9 Great Recession. So, not only did the Yield Shield not solve Sequence Risk. The Yield Shield made it worse! And, as promised, here’s a followup post to deal with some of the open issues, including:

  • A more detailed look at the reasons for the Yield Shield Failure over the past 10 years (attribution analysis).
  • Past performance is no guarantee for future returns. How confident am I that the Yield Shield will fail again in the future?
  • Dividend Yield vs. Value
  • Are non-US investors doomed? Probably not!

So, let’s look at the details:

An autopsy: Attribution analysis of the Yield Shield failure post-2008/9

Going from a simple and clean 60/40 portfolio as in the Big ERN world to the convoluted mess of the Yield Shield portfolio took a lot of work. To understand how much of each of the individual pieces of the Yield Shield contributed to its failure, let’s look at the following sequence of portfolios, changing one portion of the portfolio at a time:

  • Portfolio 1: 60/40 as defined here in the SWR Series: 60% S&P 500 index and 40% 10-year Treasury Bonds, closely approximated with the IVV and IEF ETFs, respectively.
  • Portfolio 2: Replace 10% of the IEF with AGG (U.S. aggregate bond index, i.e., including investment-grade corporate bonds). Note: AGG is an almost identical substitute to the BND.
  • Portfolio 3: Replace another 10% of the IEF with LQD (exclusively corporate investment-grade bonds)
  • Portfolio 4: Replace the remaining 20% of IEF with PFF (Preferred Shares)
  • Portfolio 5: Replace 30% of IVV with VEU (non-US stocks)
  • Portfolio 6: Replace 15% of IVV with VTI (US total stock market)
  • Portfolio 7: Replace 10% of the IVV with USRT (US RETIs)
  • Portfolio 8: Replace 5% of the IVV with VYM (US high-dividend yield)
Going from Big ERN’s 60/40 to Millenial Revolution’s “Yield Shield” one step at a time. Yields as of 2/26/2019, according to YahooFinance and FinViz.

Let’s see what was the marginal impact of each of the changes. Let’s start with just the plain portfolio stats, not factoring in withdrawals (yet), but simply looking at return, risk, Sharpe Ratio (=risk-adjusted return), worst drawdown, and a simple “factor” model to estimate the exposures to stock and bond betas.


  • Returns get worse, the risk gets worse, the Sharpe Ratio gest worse and the drawdowns get worse as you move along the steps to the Yield Shield portfolio. There is one tiny improvement to the mean return in step 6 (replacing the IVV with the extremely highly correlated % VTI) but that’s very minor. Also, the Sharpe was the same and the drawdown a little bit worse.
  • Someone in the comments section conjectured that most of the underperformance is due to the overweight in international stocks. And that’s certainly true, notice the big step down in the average returns and Sharpe Ratio came about in step 5 when adding international stocks. But notice that Preferred Shares (added in Portfolio 4) take your portfolio down pretty dramatically as well; not so much in the average return but the drop in the Sharpe Ratio is awful. So is the Worst Drawdown.
  • Is the underperformance just a statistical fluke? Of course not! As you go from left to right you see that you keep increasing your equity exposure, as estimated by a simple style analysis (factor model). To the untrained eye, you may think you keep a 60% equity, 40% bond exposure. But in portfolio 4, when you supposedly only reshuffled the fixed-income portion you’ve gone to an effective 75/25 portfolio. No wonder it had steeper drawdowns and less diversification. Shifting from government bonds to corporate bonds and preferreds introduces equity beta through the backdoor!
  • Messing with the equity portion (portfolios 5-8) takes the equity beta to above 83%. Again, not by increasing the equity share but by shifting into higher risk and higher beta instruments. The Gov. Bond beta is also above 40% again (thanks in large part to REITs), so the whole Yield Shield portfolio was essentially a leveraged bet on equities plus bonds but minus a pretty bad portfolio alpha.
Nominal Return Stats of the 8 portfolios: May 31, 2007, to January 31, 2019.

What about the portfolio performance when we take into account the withdrawals? In the chart below, I plot the time series of the portfolio values when we withdraw 3,333.33 each start of the month (i.e., 4% annualized). This is with double inflation adjustment: 1) withdrawals are adjusted by CPI and 2) the portfolio value is CPI-adjusted. The biggest step down is when you introduce international stocks. But notice how even the fixed-income portfolio adjustments already cost you almost $90,000 by 2019.

Time series of the 8 portfolios when withdrawing using the 4% Rule. Note: Both withdrawals and portfolio values are CPI-adjusted.

Let’s also dig a little bit deeper into the Yield Shield underperformance. In the table below, I display the final portfolio value, i.e., the endpoint of the 8 lines in the chart above:

  • We can dispell the myth that this is all due to bad luck of picking international stocks. Or REITs. 28% of the underperformance ($81,205 out of $288,342) is due to the fixed income portion. True, that’s less than the 40% share in the portfolio but keep in mind that the fixed income portion also has lower risk, hence the slightly lower potential for messing up your portfolio.
  • It is indeed true that the largest chunk of the Yield Shield underperformance came from the shift to international stocks. Out of $288,342 underperformance, $190,705 or about two-thirds came from shifting into VEU. But all of the other moves also look pretty bad.
  • Quite intriguingly, the one single step that – at the margin – increased the final portfolio value was replacing 15% of IVV (S&P 500) with the VTI (U.S. Total Market) and that was the one step that decreased the overall portfolio dividend yield. In other words, the one step that (very marginally) helped you with Sequence Risk was going against the Yield Shield plan of increasing yield! So, if you calculate how much final portfolio value you gained per basis point (bps=0.01%) of additional dividend yield, all seven measures are negative! The inventors of the Yield Shield are either the most unlucky or the most incompetent financial planners: they are 0 for 7! It’s so bad, you almost can’t make it up!
The final portfolio value (CPI-adjusted) in January 2019 when withdrawals follow the 4% Rule. Top panel: Dissecting the impact on the final value of the seven portfolio weight changes. Bottom panel: attribution of sequence risk. Especially the preferred shares and international stocks caused the failure of the Yield Shield portfolio.

In the bottom portion of the table, I also like to dissect the Sequence Risk a little bit more:

  1. Start with the nominal return without withdrawals of each of the portfolios. Example: 6.36% for portfolio 4.
  2. Deduct CPI inflation (~1.73% annualized over this time span). Example: 4.56% for portfolio 4.
  3. Deduct your 4% real withdrawal mount. Example: 0.56% for portfolio 4. In the absence of sequence risk, Portfolio 4 should have grown by (approximately) this much after the withdrawals.
  4. But the actual CAGR net of withdrawals can be very different. Example: portfolio 4 actually shrank by 0.36% p.a.,…
  5. … and that difference is the impact from Sequence Risk! In the case of Portfolio 4, it’s -0.91%!
  6. We can also assign the marginal impact on this Sequence Risk impact as we move from the 60/40 portfolio over to the yield Shield.

The reason I like this type of attribution is that we’re able to separate the underperformance due to simply the average return vs. “pure Sequence Risk.” Remember: This isn’t so much about the average return, it’s about the order (sequence) of returns, hence the name. The Yield Shield worsened the SoRR effect from -0.51% to -1.20%. Preferred Shares were actually the worst offender. More than half of the deterioration came from the three fixed income moves, almost half from Preferred Shares alone. And again: International stocks drag down the final portfolio value not just because of their inferior average return but also the bad sequence of returns!

So, this was my pretty thorough autopsy of the Yield Shield method. The conclusion is that this horse is really, really dead. No need to beat it any further!

Looking forward

We are all familiar with the “Past performance is no guarantee of future results” disclaimer. And this disclaimer applies here as well. Just because the Yield Shield would have failed the last time around doesn’t automatically mean that it will fail again. But we should also recognize the great irony here: Normally, when people propose “better” asset allocation recipes it’s the critics who invoke the “Past performance is no guarantee…” disclaimer. And the proponents bury that pesky little disclaimer deep in the fine print. Here it’s the other way around! The inventors of the Yield Shield would have to invoke it, hoping that their proposed solution to shielding investors from Sequence Risk doesn’t fail quite so miserably next time. Actually, “not failing” is not enough, right? Let’s not shift the goalpost here because you should do better than the passive 60/40!

So, how confident can we be about the Yield Shield failing again in the future? It depends. Different asset classes will have a different likelihood of repeating the past experience:

Fixed Income:

We can say with near-certainty that the fixed-income portion of your portfolio will behave very similarly to the 2008/9 episode once the next big bad bear market comes along. In other words, in the next big recession, higher-yielding corporate bonds will underperform the safe and low(er)-yielding government bonds. But, you ask, wouldn’t corporate bonds benefit from a likely rate cut by the Federal Reserve? True, but the recession will also raise credit spreads, i.e., the difference between corporate bonds and safe government bonds. And that means that in financial stress scenarios, low-yielding government bonds will handily outperform high-yielding corporate bonds. With great regularity; it has happened in every recession in the past (see chart below) and it will surely repeat in the future.

The credit risk premium poses a challenge during recessions. The riskier the bond the more of a Sequence Risk danger you face. Every Single Time! This is based on annual data from PortfolioVisualizer. If I’d had monthly data available I could have made this chart even more impactful because you can pinpoint the start of the recession/bear market down to the month, not just year-end!

Also a word about Preferred Shares: people have pointed out that most of them are issued by financial institutions and that clearly hurt them during the financial sector meltdown during the Great Recession. 100% true! But again, let’s not shift the goalposts; preferreds don’t have to perform as poorly as in 2008/9. They merely have to perform worse than safe government bonds. And preferred shares will not only be subject to that same corporate credit spread issue above, but they will also suffer even more due to their subordinated debt structure. Unfortunately, I don’t have a long enough history of either ETF or a Preferred index performance at my fingertips to test my hypothesis prior to 2007. If anyone has a longer data series of Preferred returns please let me know! I’m sure they will look similar to the High-Yield bonds in the chart above!

U.S. vs. international Stocks:

I am reasonably certain that during the next U.S. recession and the deep bear market that goes along with it, there will be very little diversification from international stocks. As I wrote in the post from a while ago, if we see double-digit losses in the U.S., your non-U.S. portfolio will get hammered, too. It has happened in every single recession in recent history, see the chart below from an old post of mine:

Diversification Chart02
From my 2017 post on international diversification: Scatterplot of YoY returns: U.S. on the x-axis, World ex USA on the y-axis.

That said, I have no idea how international stocks will perform during the subsequent bull market. If you look at that funnel-shaped cluster of dots above you’ll notice that the widest dispersion of dots occurs to the right. There have been instances where the U.S. return was +20% year-over-year and the non-U.S. return ranged between -10% and +70%! So, in all fairness, there could be an opportunity for international stocks: maybe they will outperform U.S. stocks again during the next Bull Market (whenever that may be). It has happened before, see the summary table from that old post of mine below!

Diversification Table01
From my 2017 post: Real (U.S.-CPI-adjusted) total returns of various indexes during drawdown and recovery periods: 12/1969-5/2017. Notice, EM is available only after 12/1987.

You see, from a Sequence Risk perspective, it matters not just how deep the bear market is and how long it lasts but also how long it takes for the subsequent Bull Market to recover. In other words, your Sequence Risk worries aren’t over until the Bull Market takes your portfolio back to “normal” to recover 1) the loss during the Bear market, 2) Inflation and 3) your withdrawals. There have been instances in the past where the equity market recovery was significantly stronger abroad (e.g. 1982-1987 and 2002-2007). As I wrote in that post in 2017, it is definitely noteworthy that non-US stocks significantly outperformed US stocks following the 2000-2003 bear market (see chart below). But let’s be clear: Nobody in their right mind would claim that this is because of the higher dividend yield! It had to do with (at least) two effects 1) FX movements: the USD depreciated against other currencies, and 2) macroeconomic divergence.

Diversification Chart03
From my 2017 post: A 2000-2007 case study. Global equities exactly mimicked the U.S. Dot Com Bubble crash. Zero diversification! But the recovery was much better abroad!

And by the way, the underperformance of non-US stocks since 2009 is also largely due to those two effects simply working in the opposite direction: 1) U.S. macroeconomic performance, though weak in absolute terms, was strong relative to other countries, and 2) the USD appreciated again and that makes the equity performance abroad weaker from a USD-based investor. It had nothing to do with dividend yields.

So, what can we predict now? Nothing. Absolutely nothing! That’s because I can predict neither macroeconomic trends nor FX movements that far into the future. I don’t want to make the case that VEU will underperform again and others shouldn’t make the case that VEU will necessarily outperform the U.S. index. Certainly not because it has higher yields! As a working assumption, I’d simply use the same expected returns here in the U.S. as in the ex-U.S. ETFs. So, in other words, my conclusion on the U.S. vs. International stock market is significantly weaker than for the fixed income bucket. For the fixed income assets, higher yield, almost by definition, means higher macro risk and worse performance next time we have an adverse Sequence Risk event. For equities, the higher-yield approach doesn’t necessarily make Sequence Risk worse but there’s also no guarantee it would necessarily alleviate Sequence Risk. Looking forward, it’s a wash! That’s still a far cry from the absolutely asinine promise of the Yield Shield “protecting” or “shielding” (their words, not mine) you during the next recession.


I’m no big fan of REITs. I think there are superior investment vehicles to get access to real estate: either manage your own properties – check Coach Carson’s blog for an excellent intro (I especially like the post on house hacking) – or take the more passive route through one of the real estate syndication platforms. Or even through traditional private equity funds as we do here in the ERN portfolio; very hands-off and passive! For investors who are absolutely opposed to those routes, sure, go ahead and invest in REITs. They will likely not get hammered as badly as in the last recession. But I see no reason why REITs would deliver reliably superior total returns during the next Sequence Risk scare. It’s the same conclusion as in the U.S. vs. International discussion above. I can provide theories for why REITs will outperform next time – if there’s an inflation shock REITs are a good inflation hedge – but also why they may get hammered again in the next bear market: They’re over-priced already plus too much leverage could bite you if there’s a spike in interest rates. Ex-ante, it’s a wash!

Wow, I only got about halfway through what I wanted to accomplish today and we’re already close to 3,000 words! I think I will cut this post into two and publish the remainder later this week. There, I will summarize some more of my thoughts on the “Looking forward” section, elaborate more on my views on the U.S.-high-dividend tilt and some other issues. Have a great start of the week, everyone!

Thanks for stopping by today! Please leave your comments and suggestions below! Also, make sure you check out the other parts of the series, see here for a guide to the different parts so far!

Picture Credit: “Yield” (cropped image), taken by seabamirum, via Flickr. Copyrighted material, used with permission. Some rights reserved.

71 thoughts on “The Yield Illusion Follow-Up (SWR Series Part 30)

  1. This series is the gift that keeps on giving! Nice addition Karsten. Chasing yield through stocks and bonds only is indeed a dangerous game. I am not a fan of REITs either (too much leverage). That is why I opted to increase my overall portfolio yield and reduce risk through other asset classes like private equity and real estate. Vanguard says the next decade will be for international stocks. Gundlach predicts that the 10-year Treasury yield will be 6% by 2021(!). Who knows what will happen. Stay diversified and enjoy the ride.

    1. Very wise choice. Clearly, there is nothing wrong with wanting income/yield. But probably Real Estate, either directly or the PE route, might be the better choice for that. Just like you, that’s where we are shifting our focus now! 🙂

    2. Wow Gundlach’s prediction didn’t age well at all! Even before the pandemic, yields were falling sharply down to the 1.5% range. As far as the so called experts that make public predictions, I generally think he’s decent but it just goes to show you how hard market timing is.

  2. probably too complicated to model, but i wonder about the effect of post-tax accounts benefitting from qualified dividends, real estate depreciation, capital gains rates and so on. all these analyses work if all the investments are in tax-sheltered accounts [e.g. ira’s], but it’s less clear what happens post tax.

    1. Yeah, what people would normally do is a rough estimate of both marginal and average tax rates out of both taxable and tax-deferred accounts, then calculate how much you need to withdraw pre-tax to meet their post-tax target.
      Luckily, for a lot of us in the lean and standard-FIRE crowd, we should have relatively low effective taxes, probably less than 10%, maybe even 0% if we max out the standard deduction and 0% cap-gains/dividend brackets. That’s why tax-considerations are often just an afterthought.

  3. To some extent, “analysis paralysis” is kicking in for me. Some observations/concerns:
    – It seems that many “dividend” analysis articles, across the web, treat all dividend payers the same. Which makes about as much sense as treating all stocks or all bonds the same. There are some dividend stocks that vary their dividend based on performance (or lack thereof). Others consistently pay a dividend and increase it every year, 3M has done so for 61 years. GE is an example with a great record until it didn’t. provides a great spreadsheet relative to this
    – As proxies for the analysis, Many of these articles use funds (managed or indexed). Thus you experience the “average” problem as part of the analysis.
    – Using the Excel spreadsheet from:, I plotted Div Yield vs CARG (as an approximation (poor?) for stock growth). High Div Yields tend to grow slower and vis-a-versa. This plays to some of your images in part 1 of this article.
    – You are only guaranteed a bond’s performance if you hold it to maturity. 10yr 6%Treasury Notes, based on interest rates at time of sale, may lose (or gain) some amount if you need to cash in early to avoid stock sequence of withdrawal risk.
    – Bond funds are totally different beasts from holding individual bonds. More-so than stock funds vs holding individual stocks.
    – To some extent, 3M (and similar) works like a T-Bill or bond … “Like”, not “exactly like”. Like a bond, you may see yr-over-yr dividend payments but the stock’s value may change … either way.

    I think my feelings are that the “dividend” baby is often thrown out with the bathwater. It would be interesting to view an analysis of holding dividend aristocrat stocks (maybe a dividend aristocrats fund). With current bond yields so dismal, dividend aristocrat stocks provide an interesting option. And like seeking high stock value growth, seeking high dividend yield is riskier than consistent payment & growth at lower yield.

    1. Very nice insights!
      Thanks for the link to the dividend vs growth chart! Very useful!
      I’m also a bit nervous about the “fallen angel” syndrome: when dividend aristocrats fall out of favor they might get really hammered (GE).
      Bond futures keep the maturity (almost) constant, so you get the duration effect when interest rates change. But most investors actually WANT that. That helps with diversification. In most (not all) recessions.
      Very true about the consistency of dividends. Note how some of the dividend aristocrats actually pay lower dividends than even the S&P!
      Thanks again!

  4. Thanks for the follow-up Big ERN. Good stuff!

    I look forward to seeing the next part where I hope you’ll talk a bit about the relative advantages (esp. for beta) of focusing on quality dividend-paying stocks, such as in the SDY etf. Reaching for the highest yield is a good way to be catching falling knives and buying doomed companies (junk bonds in the 80s are a great example), but add quality and value filters and those healthy dividend-paying companies and funds start to look pretty attractive.

    Using this approach in my own investing and backtesting it, I see a little alpha and improved beta (which may help with sequence risk, which is what I hope you might be able to calculate). SDY has outperformed SPY since inception but not every year and not by a ton (though it really adds up over time). In a 60/40 portfolio replacing SPY with SDY and adding BND for the bonds produces what look to me like clear advantages for SDY, but BND only backtests to Jan 2008 in portfolio visualizer.

    But this is more about a value, quality, and dividend filter being applied to investment choices than about producing the “yield shield” or even about chasing yield. Some of this may also have to do with the changes in the S&P 500 membership over the past decades, which has made it much less a stable of the biggest and best and more a menagerie of the best mixed in with the most bloated (Netflix, for example).

    Anyway, like I said, I’m looking forward to the next installment!

    1. Very good points! Thanks for pointing me to that SDY fund. I have looked at the constituents and there’s quite a bit of overlap between the two sleeves I already have in my M1 account (NOBL and my own dividend+quality+value). But I made another sleeve and replicate the SDY as well. Looks promising!

        1. Interesting! It has a very low ER (0.07%) but they do a quality screen. And they avoid REITs, so this is good for taxable accounts:

          SCHD is a market-cap-weighted fund whose selection universe only includes firms with a 10-year history of paying dividends. Within that universe, SCHD uses fundamental screens (cash-flow to debt ratio, ROE, dividend yield, and dividend growth rate) to build its portfolio. This approach gives the fund a modest large cap tilt, and creates sector biases toward industrials and consumer stocks and away from financials, while it excludes REITs entirely.

          It has too short a history to properly backtest it through the GFC, though. Thanks for the tip!

  5. This is a great series, parts 29-30 in particular. The Yield Shield portfolio leaves much to be desired as you have detailed. The analysis gets close, but does not answer questions I have been wrestling with lately. I’m evaluating a 27.5x portfolio with 2.5x annual spend in an after-tax cash bucket and 25x annual spend in a tax-deferred bucket. The portfolio was invested for total return in the accumulation phase but will be invested for dividends in the retirement phase. IMO, the concept of living off of dividends in retirement requires two critical deviations from the Yield Shield portfolio:

    1) The portfolio of 25x spend would be 100% in dividend paying stocks, with heavy exposure to international markets and an initial yield >=4.0%. International exposure not only helps with geo-political diversification but also helps with higher yield and most importantly better sector diversification. International dividend funds often yield > 4%. And a US portfolio of 50+ individual stocks in the 3rd and 4th quintile of yield can also yield >4%. For simplicity let’s just say the portfolio is 40% VYM (3.2% yield), 40% VYMI (4.0% yield) and 20% EWA (5.7% yield) for a weighted average yield of exactly 4.0% in year 0.

    2) Only income from the dividend portfolio is withdrawn; the shares never change. The dividend portfolio and the ERN 60/40 portfolio both start with $1M of principal and $40,000 withdraw in the first year. The ERN 60/40 annual withdraw increases with the rate of inflation while the annual withdraw from the dividend portfolio is equal to dividends earned each year.

    Is the dividend portfolio viable? Let’s look at the potential problem areas you mapped out:

    Potential Problem #1 – Efficient Markets: The better yield portfolio must have a lower price return in order to have the same or lower total return as a traditional portfolio. This is important to note during the accumulation phase. But if you don’t touch shares in retirement (living off of dividends only), the lower return from price and the potentially lower total return are a moot point (except for maybe your heirs).

    Potential Problem #2 – Confusing nominal and real returns: Equity dividends grow much faster than inflation over the long-term. With no bonds, preferred shares are other fixed income in the dividend portfolio, problem #2 is a moot point.

    Potential Problem #3 – More yield may imply less diversification: The 100% stock dividend portfolio does not have bond or bond alternatives. The dividend portfolio will have greater price volatility than the ERN 60/40 portfolio without bonds to help stabilize the total. But if no shares are being sold, price volatility in itself is a moot point. The dividend portfolio will have a fewer number of companies and so it does have less company diversification than a traditional portfolio.

    Potential Problem #4 – Dividends can be cut: This is where sequence risk can still hit the 100% stock dividend portfolio. Dividend cuts can reduce retiree income for a few years. Net dividend cuts in 2000 took 2-3 years to recover and net dividend cuts in 2008 took almost 4 years to recover to new highs. However, dividend growth (even with these corrections) has been shown to still outpace inflation. If a short-term income cut cannot be accommodated by the retiree, the 2.5x cash bucket is a safety net. Note that REITS and Preferred Shares are bigger problem areas and not in the proposed dividend portfolio.

    In conclusion, I think the 100% stock dividend portfolio with initial yield of 4%, eliminates sequence risk (as defined as selling shares when prices are low) and establishes a clear SWR (always equal to the dividend income generated each year). On the downside, this portfolio should trail a “total return” 100% stock-based portfolio and will have fewer companies making up the diversification. This portfolio will also lead to short-term (2-4 year) drops in retiree income that should be coupled with a cash bucket strategy.

    Any other considerations that I am overlooking as I evaluate this approach?

    1. I think some of what you are saying is … if spending is <= earnings (dividends), then why do I care what the stock price is? Short of it going to ZERO! If I have $10M paying $200,000/yr, increasing year over year at 5% and I'm spending $150,000 increasing yr/yr at 2.5% I'm not particularly concerned in stock price.

      And I agree with this. That is why I think too many analysis treat every investor the same. There are at least three categories and each has differing solutions (although there may be overlap):
      1) Savings well below needs
      2) Savings really close to needs
      3) Savings well above needs

      For many, the problem to be solved is #2 but when you actually pull the retirement trigger (early or late), you must play to one of the 3 that fits.

    2. Sounds like a great plan. But as I showed in my post it can backfire.
      Example 1: U.S. stocks had dividend yields significantly above 4% early on. See this post:
      Especially this table:
      So, why did the 4% Rule and 100% equity portfolio fail during the Great Depression when dividend yields were so high?

      Example 2: VEU (non US ETF) and EWA (Australia ETF) have nice high dividends. Didn’t protect you in 2007-9.

      But again, I’m not saying that this will happen again. I’m just saying that this dividend strategy has failed several times in the past.

  6. This is a well done analysis. I guess I now have my answer to the question of why anyone would buy a treasury. The chance to rebalance during a correction is what makes it worthwhile.

    My AA in non-401k accounts is 95% hedged stock ETFs, 5% bonds, fun speculations, and cash. I hedge with LEAPS put options in order to tolerate more equities.

    This analysis of how, in a correction, low yielding treasuries outperform riskier bonds makes me think about my put options. Options have virtually no risk of default, but the risk-free rate is built into the numerator of pricing models so that falling rates work slightly against options values. So falling rates have a small effect in an opposite direction than with bonds. This is obscured by the rapid appreciation of the puts during a correction due to Delta (price change) and Vega (volatility).

    I wonder if the time decay of my put options (Theta) plus the anticipated losses due to interest rate changes (Rho) relate in some formulaic way to the interest I could have earned in an alternative stock/bond portfolio in which the bonds pay interest instead of decay but the options offer a bigger hedge per dollar and limited downside. [head spinning]

    1. Probably, there isn’t an exact equivalent between a 95/5 plus LEAPS vs 60/40, but qualitatively it might be similar. There’s no free lunch. How much do you estimate you lose on buying the LEAPS, on an annualized basis?
      I sell put options (but very short-dated) and always play with the thought of buying some LEAPS. But only tactically when IV is low. Otherwise, if you have to buy protection when the market is down it would be way too expensive.

    1. Indeed, it landed in the spam folder. Not sure why.
      Nice blog post. It worked if you start in 2000. It wouldn’t work if you start in 2007. But we knew that already. VEU would have worked much better in 2000-2007 as well. The whole idea is that high-yield stock indexes can be a crapshoot: sometimes they work sometimes they fail miserably. It’s a far cry of what is being advertised. 🙂

  7. You can similarly argue that over weighting Growth (low dividend) stock would improve all of those metrics. I mentioned this in last article too, but again the 12 year time frame matters.

    What purpose do you think preferred serve? You have a significant part of your portfolio in preferred shares. Why?

    Also, the 60/40 or gliding path(s) is better for the withdrawal phase. What about accumulation phase? The “easy” answer is 100%+ equity… yet, few advocate that. If there is value in diversification to international, then there us merit in holding international during the accumulation phase?

    “real estate syndication platforms” Are you referring to not-publicly traded REIT (two heavily advertised website come to mind). Do you not see worse potential for corporate governance failures in those? They are extremely opaque and almost unaccountable for any self-dealing they may engage in.

    Looking forward to the second part!

    1. Agree on growth stocks.

      I hold Preferreds in my option trading account. I have to keep a large pile of margin money sitting around because I only sell SPX puts and never have to post principal for this (unless the puts go into the money).
      Where to hold the margin cash? Mostly in Muni bond funds (i.e., State, Municipal governments, etc.) but I also put some money in Preferreds. And you know what? For exactly the reason as Millenial Revolution: For higher yield! 🙂
      But I make sure I don’t delude myself into believing that this is without sequence risk.

      While accumulating, sure, go with 100% equities if you like. I did that myself. I even advocate it, certainly for people just starting out saving.
      While withdrawing you face Sequence RIsk and then it’s time to be a bit more cautious.

      With the platforms, I mean EquityMultiple, etc.
      I can’t vouch for them but I like the PE funds I work with. They send me their balance sheets, cash flow tatements, even general ledger every quarter. Less protection than in a publicly traded corporation, but it aint’t a black box either. 🙂

      Thanks, Dan!

  8. very interesting results and wow did it sure generate a lot of posts! i’m wondering if using the 60/40 with IVV and SHV (short-term treasuries) instead of IVV and IEF might be a better tactical position now since we’re probably still in a long-term rising rate environment – just a pause at the moment – and IEF’s duration is a lot larger than SHV’s duration. any thoughts?

    1. The SHV vs IEF issue is very important! If we have an inflationary recession as in the 1970s you’d do better with a short-duration bond fund (SHV). If it’s a recession like 2007-9 (demand shock, i.e., deflationary) you’d benefit from long duration.

      1. Thanks. Enormous growing govt debt + temptation for future politicians to inflate the debt away + increasing interest in socialism among young uninformed people + increasing hostility toward wealth creation in the culture and mainstream media and academia = possible future stagflation and declining economic prospects for US. Maybe hedge bets and split bond portfolio between IEF and SHV.

        1. Thanks, Andrew!
          True, we are raising the risk of an inflationary shock. I’ve been thinking about how to hedge against a stagflation scenario, too. SHV will do better than IEF of TLT in that scenario! If it makes you sleep better, go for it!

  9. Hey, Big ERN — I do have one other question about the analysis throughout this series and in the ERN google sheets tool as well:

    Is there a way to account for the anomaly of the 1980s bond returns? If, as I think is true, we may never again see bond returns as high as they were in the 1980s, how much does including the 1980s in or backtests distort our expectations of the value of bonds and the power of the 60/40 portfolio? A little statistical wizardry should be able to replace the 1980s (esp 1982-1986 or so) with numbers that are more in-line with the broader sweep of bond performance, “cleaning up” the data, so to speak. Would doing so change how we view the cherished 60/40 or the utility of bonds in general?


    1. Good question! I would not discard the possibility of a 1980s repeat. Maybe not quantitatively (going to almost 20% rates). But qualitatively, we’ve gotten way too accustomed to negative S/B correlations. I wouldn’t be surprised if that could change in a future recession.
      If you’re absolutely 100% sure that we’ll never have a 1970s/80s experience again, then ignore that time period. In the Google Sheet you can see the fail-safe SWR by subperiod. Just igore the numbers from the 1960s/70s.

      1. In my opinion 1980’s was due to policy and women’s liberation. In 1978 Carter signed a bill that disconnected S&L interest from prime, previously it was linked to a fixed spread (spawning the S&L crisis). The uncoupling turned S&L’s into credit cards with spiking interest. Also in the 70’s women went to work. In 1960 the average family could afford the average home on one salary. By 1980 women entered the workforce in large numbers spiking inflation since families were now making more per family and the average house had inflated to cost to 2x the average income. There is no going back and no third “member” in the family to send to work to improve family productivity, hence I believe 1980’s was a one off.

        1. The standard explanation is Paul Volcker and Fed sinking the economy with rate hikes inflation shocks of the 1970. Inflation was due to easy monetary policy during the late 60s coupled with the two oil shocks. The easy monetary policy part is already underway (way worse today than in the 60s). Not sure what could set of the next inflation shock, though. I don’t believe that the 1980s can’t repeat!

          I’m not wading into any other political gender-issue discussion, for obvious reasons. 🙂

  10. “It wouldn’t work if you start in 2007”.
    I don’t understand this comment. The article has a 2007 scenario and while the portfolio value is still lower 10 years later, the number of shares were never touched and the income received from the portfolio started at 4% and increased with inflation. What failed?

    1. There is no guarantee that a) the dividends won’t be cut, b) the dividends will recover to your intial budget + inflation, and c) the portfolio value will recover to initial value plus inflation.

  11. Great technical analysis in the link. But I don’t follow how it addresses my point? I am suggesting that retiring on a dividends-only strategy on a 100% stock dividend portfolio with initial yield of 4% eliminates sequence risk (as defined as selling shares when prices are low), establishes a clear SWR each year (set equal to dividend income), and eliminates timing the market each quarter (since shares are never sold). The downside to the strategy is that some diversification is lost and the retiree must deal with choppy income from year to year, though the long-term dividend dollar income will grow faster than inflation.

    Comment 1: “VEU and EWA have nice high dividends, but didn’t protect you in 2007-2009”.
    Protect from what? Yes, those ETFs took a price hit and some dividends were cut during 2007-2009. But by only drawing dividends and not touching shares, the dividend investor still withdrew dividends in excess of inflation-adjusted income pre-recession. EVU only goes back to 2008. EWA portfolio income of $1,000 invested in 2005 (dividends not reinvested)
    2005: $40
    2006: $66 (avg of $53 over 2 years)
    2007: $76 (avg of $61 over 3 years)
    2008: $53 (avg of $59 over 4 years)
    2009: $40 (avg of $55 over 5 years)
    2010: $50
    2011: $65
    2012: $81 (10.6% annualized dividend income growth)

    Comment 2: “Why did the 4% rule and 100% equity portfolio fail during the Great Depression when dividends yields were so high?”
    The 4% rule failed because shares were sold at low prices to maintain a given income level, adjusted for inflation. The dividend-only model doesn’t sell shares, so the portfolio never goes to $0. Dividend income also dropped during that time, making for some lean years of income before dividend payouts rose again to new highs in terms of dollars (not yield).

    Comment 3: “US stocks had dividend yields above 4% early on but now near 2%”
    Okay, but the individual stocks held back when the market was yielding >4% are not paying half of the dividend dollars today as they did back then. I agree that it requires one to be more selective today to get a portfolio yield near 4% and some diversification is sacrificed to do so.

    I am evaluating how this dividend-only strategy (with choppy but rising dividend dollars) compares to a dynamic 4% rule with guardrails, glidepaths, ratcheting, etc. Any insight appreciated.

    1. If dividends per year exceed spending per year, I would argue it will not fail. The “if” risks are:
      – you have an “Enron” in your portfolio
      – you have a “GE” in your portfolio (GE was an Aristocrat until it cut dividends)
      – you include stocks that allow their dividends to both increase or decrease. (I avoid these and that is my personal choice)

      BUT … because those risks are realized, does not mean that the plan will fail. An often overlooked detail is “spending variability”. Will you spend exactly to income payments? Do you “have to” spend to income each year? Probably not and most will manage to less, not more (including funding/defunding an emergency account).

      I view spending as two components:
      – Musts (food, water, utilities, clothing, shelter and similar. Some items are not “true” musts but I include them anyway)
      – Wants (travel, toys, fun stuff)

      Depending on what happens to the income stream, I will vary the “wants” in order to secure the retirement funding plan.

      Note that the dividend yield is irrelevant. If the yield is really really ow but you are living to that income stream then you are golden. Yield by itself is irrelevant. Where yield is important is if you are pulling the trigger as soon as possible and you are trading “risk” for yield. More yield = more risk for the most part.

      Note a big down side … you die rich (better than broke). But I propose that as you age, you can change the plan. Do you really need $4M when you are 80?

      1. In Operations Research there is discussion of “Optimal” vs “Strong Feasible”. I propose too many folks planning their retirement funding spend too much time searching for optimal whereas strong feasible solutions are close to optimal with less risk.

      2. Good points. If you look at the performance of stocks that have stable yields today you ignore the failures along the way. Survivor bias. Buyer beware!

        Die rich? That’s not a problem. I’d certainly ratchet up my withdrawals if I’m decades into FIRE and I see that my portfolio is way up. Who would be stupid enough not to?

    2. Comment 1:
      First, starting in 2005 we never have a problem with Sequence Risk. Only when we start in 2007 would the 60/40 or the high-yield portfolio get into trouble.
      The exact simulations on why this fails are in the upcoming post on 3/6/2019.

      Comment 2:
      Sorry, I wasn’t clear when I desribed that. I meant that the div yield was 4% before the Great Depression. It dipped under 3% right at the market peak. Your dividend strategy, never sell a share and live off dividends only, would have failed then. You suffer deep cuts in dividend income and it would take years or even decades to recover your initial dividend income.
      See this chart:
      The real, CPI-adjusted dividend income dropped by 40-45% and it took until the 1950s to get back to normal. Good luck with this!

  12. Nick,
    Thank you for your insight. I understand and agree with everything you said. Good points.

    Just one additional clarification… You say, “note a big downside is you die rich”. I agree. But the average outcome of a 30-year static 4% draw (inflation adjusted) on a 60/40 portfolio is ending the 30 years with ~2.8x the amount from which you began. The 10th percentile outcome is like 90% of your starting amount and the 90th percentile outcome is over 6x your starting amount. I’m thinking that the dividend-only model results in a tighter range of outcomes over 30 years…. maybe 1.5x to 3x the starting point.

    1. So much depends on the profile of your investments. Using
      – Ticker: T (AT&T) has a 6.56% yield but the Dividend CAGR is about 2%.
      – Ticker: MA (Mastercard) has about 0.56% yield but the Dividend CAGR is in the 13% – 36% range

      All things being equal (which they seldom are), the dividend payout cannot grow without a corresponding growth in the underlying stock price or else the yield percentage gets out of whack.

      In a living on the dividends approach, your “remaining balance” would be a lot more with MA than T as measured by multipliers against starting value due to stock growth alone. (of course, you need to start with a lot more of MA to live off of it as well as similar payouts from T).

      And that begs a derivative to the title of this post … does it make sense to move into higher yield, slower growth dividend aristocrat stocks during retirement? (Not to be confused with simply high yield)

      The perfect retirement stock …0% stock value growth with yr-over-yr dividend growth that exceeded your cost of living increases. Any suggestions 🙂

      1. Very good points. I thin kit certainly makes sense to shift into some form of dividend aristocrats/champions/etc. where the initial yield is high enough to guarantee a high enough SWR, and the stock price and dividends grow in line with CPI (or whatever COLA I use). This would be ideal for capital preservation.

        Also that link is a treasure trove. Look at the dividend champions from back in 2008. Quite a few names cut their dividends going forward. Or are no longer with us! 🙂

        1. Agree that the Spreadsheet & PDF link is a treasure trove! And they offer it free … no strings attached. I was worried when the David Fish, the creator, recently died but it has been picked up by someone else. HOOOOORAY. It would be interesting to see a similar spreadsheet for indexed funds.

          Some aristocrats have departed and some new ones have joined. Maybe indexed funds modeled after the aristocrat profile help modulate those bumps. SCHD (I own some of SCHD) is an example. For those looking at the dividend stream from SCHD, it seems to fluctuate (which it shouldn’t holding aristocrats) but when the numbers are summed per year it does slope upwards. It doesn’t have a long history since it started in 2011 as far as I know.

          Note that I’m not saying this the best alternative, just another one to consider.

    2. But the average outcome of a 30-year static 4% draw (inflation adjusted) on a 60/40 portfolio is ending the 30 years with ~2.8x the amount from which you began.

      Sorry to tell you this, but this is demonstrably false. It’s a myth spread by a lot of people misreading the Trinity Study. That’s the nominal (and thus utterly meaningless) number. Notice how sneaky the authors of the Trinity Study were: The withdrawals were inflation adjusted. But the final portfolio values were not!!!
      The median final value is 1.14x when adjusting for inflation twice (both for withdrawals and for the portfolio value). And that’s unconditional on equity valuations. Conditional on today’s expensive valuations it’s much lower!
      If overaccumulation is a fear, let me tell you there’s nothing to worry about right now! 🙂

  13. Thanks for clarifying nominal vs real median final portfolio values from the Trinity Study. If the median final value is 1.14x the starting portfolio in real dollars, then a starting portfolio of 25x expenses would mean a median final value of 28.5x expenses in real dollars? I would consider that dying rich.

    But I would expect the median outcome in the study to end in a “saved too much” scenario, when the point was to find a SWR to survive a <1% chance of the worst possible sequence of return risk. I don't like the median outcome or how big the range of outcomes can be with a static withdraw rate. My take-away is to plan for the worst-case but use dynamic withdraw rates as you go (several methods you already explored) to not die with "too much".

    Looking forward to part 31 in the series…

    1. Oh, yes! That’s still more net worth than what you started with. But again: careful, because the median is pulled up by all those retirement cohorts that retired at or close to the bottom during bear markets. When you condition on equities above median CAPE value you’ll find lower median values.
      And another caveat: the median investor is meaningless. I worry about tail events. Not even 0.0001% tail events (like Suze Orman), but even a 10% bad outcome is unpleasant.

  14. Couldn’t you argue the REIT valuations are more definitive in that the valuation is made up of the aggregate value of all the real estate held? I believe all REITs are required by law to appraise their properties and report the aggregate value, every so often. On the other hand, the valuation of a company can have a wildly varying range from analyst to analyst. So while REITs are subject to overall market volatility, being publicly traded, you would potentially have a clearer sense of whether shares are undervalued or overvalued at any given time. I think this is a significant advantage.

    1. I’m not worried about REITs fudging their numbers. I’m more worried about low dividend yields (certainly lower than in my PE funds right now) and pretty stangant price returns. Not everywhere but in many individual REITs I looked at.
      But again, I’m not trying to talk folks out of REITs. I’m just saying there is no guarantee that the excess dividend necessarily translates into excess return.

  15. The big issue with REITs in general is their high expense ratios. If you look at the “look through” expense ratio for the Vanguard REIT it is almost 5%. One type of REIT, NNN REITs have lower expense ratios, close to 3%, so you are getting an additional 2% as an investor. What is unusual here is the FFO multiples of NNN REITs is lower than other REITs. The ones I like are STOR (4% yield with about 5% internal growth) and a private REIT that has a 6% yield & 4% growth. The internal growth is based upon contractual rent growth and reinvestment of non-distributed cash flow into NNN lease deals. Both of the firms have great underwriting, a key here as losses can eat up the cost advantages pretty quickly.


  16. What are some of the RE “syndication platforms?” Also, have you done any posts on RE (including PE RE)?

    1. For example: RealtyShares. But you’re probably familiar with all the other RE lending platforms out there.

      I haven’t done any posts yet on my own PE RE experience. It’s hard to do a definitive post on that since I only started investing in PE in 2014 and the jury is still out on how this will all turn out. Some plan to return the capital only in 2029. Until then I can only rely on the estimates of the the folks who manage the LLCs.

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