So, you want to live off dividend income only. Most people who want this believe they are not touching their principal (capital) when they do this. This essentially is a version of living off the interest and leaving principal alone. But …. that’s not true … that’s not what happens when you invest in dividend paying stocks.
When a company pays a dividend, their share price goes down by the amount of the dividend (share price also adjusts for market movements that day, so it is hard to see a penny-to-penny correlation, but it is there). There is also the illusion of income versus capital that has puzzled those who know how dividends affect the stock price (meaning your capital) as just explained.
This excellent article (CanadianCouchPotato) explains both of these effects.* Dr Meir Statman refers to how people just don’t believe this illusion in this article.
Walter Updegrave (cnnmoney.com October 5, 2012)explains how this works in an excellent article “Living Off Dividend Income” sparked by a reader’s question: ”I’d like to live off dividend income when I retire. How should I invest my portfolio?”
Fama/French (2 well known economists in the academic arena) explain also that trying to apply this approach distorts your investing such that you become concentrated in just those companies that pay dividends … thus, you are NOT diversified with your portfolio. A broad diversification is extremely important so your portfolio has a better chance to withstand the many changing market environments you will experience during your remaining retirement years.
Dividend only? First, you are spending principal when you do this, contrary to the common illusion about how this strategy works. Second, you are increasing your portfolio’s risk through lack of a broader diversification.
So how should you take income from your retirement portfolio? Through Total Return. Money does not know how it was created, either through a gain or through interest or dividends. It spends the same. By accepting some fluctuation in principal value, you actually may provide a greater chance your portfolio can generate money longer than you live (as opposed to running out of money before life). The article series that are linked to (bottom of the article in this linked article) explain how total return and distribution research work together in retirement.
*The article in Canadian Couchpotato also refers to Dr Meir Statman, a behavioral economist, who I also refer to in other blogs. His work is quite interesting as he uncovers how we think and act in relation to money.