So here I am again, working to determine the investment strategy I want to follow to hopefully lead me to a path of financial independence. This post will tackle something that I have wondered… Which strategy is better? Dividend Growth or Total Returns? I know there are a lot of passionate bloggers for each approach. This post will explore my thoughts and an analysis to help me think about it.
When I started to rethink the best path forward, I started with a “passive income” leaning. You can see this from my previous posts on S&P 500 dividends for passive income and Should I use Dividend Growth Investing. I have been thinking and would like to compare Dividend Growth vs. Total Returns (i.e. diversified portfolio with 4% withdrawal each year).
Dividend Growth vs. Total Return
I did a simple analysis looking at Vanguard’s Dividend Appreciation Index (VDAIX), comparing a Dividend only approach vs. the 4% withdrawal. The assumptions included a $3,000 initial investment, $6,000 added each year, with both the Return and Div Growth at 7% annually, and implementing the 4% withdrawals starting at year 30. I used this fund for the analysis as the fund targets both dividend growth and capital appreciation.
Based on the analysis, the Total Return approach won.
Ok, so what happens if the market drops? Let’s take a with a 50% drop in the portfolio value the year before starting the 4% withdrawals. This would be a big concern if you were relying on the Total Return approach. Interesting…over the long term, the Total Return strategy still came out on top.
Lastly, let’s look at an even worse case (hopefully this would never happen!). Let’s say the Total Portfolio takes a 50% drop in Year 29, and there is no increase in the market going forward, and the dividend from the portfolio is cut by 75%….so now the Dividend Growth Approach came out on top. Note, I didn’t cut the Dividend Growth Dividend in this example.
Reflections on this Analysis
Under normal circumstances, a Total Returns approach would provide more passive income at a point in the future vs. Dividend Growth.
If there is a downturn in the market, I would prefer to only draw on dividends and not draw down the overall portfolio.
Pros and Cons:
Pros of Total Returns: Appears to be greater chance of long term “income” by taking 4% rule, varied assets – not just dividend paying stocks, more tax efficient by picking when to sell assets vs. scheduled dividends
Cons of Total Returns: Impact of a down market when you start the 4% withdrawals
Pros of Dividend Growth: Continued increased income, conservative approach, regularly scheduled dividends
Cons of Dividend Growth: Less tax efficient vs Total Returns by taking regularly scheduled dividends even if not needed, appears to be a slower approach to long term income
Decision: Hybrid Approach!
After reflecting on my approach and the above analysis, I will take a hybrid approach. I will invest both for Total Return and Dividend Growth. I like both the potential for growth based on a Total Return philosophy, and the safety and continued growth of the Dividend Growth approach. When there is a down market, I would not feel good to withdraw principal, but I would not mind taking dividends. I’m sure arguments could be made either way, but everyone has to be comfortable with the approach they take.
I will use primarily Index funds to invest as they provide diversity and so I won’t have to perform the analysis and upkeep on a dividend growth portfolio of individual stocks.
Let me know your thoughts!