Monday, September 1, 2014

If I Had A Million Dollars

I am not sure why but when I woke up this morning the song If I Had A Million Dollars by the Barenaked Ladies was going through my head.  Always thinking about money and what it can buy for you I decided to take a look at a couple of ways of investing it.  I wouldn't be buying any houses, cars, or refrigerators with it.  Instead what if I invested it in an S&P 500  index fund or in individual stocks.

S&P 500 Index Fund
First you would need to pick one with the lowest cost.  Vanguard 500 Index fund is usually what comes to my mind.  Whenever I have a choice at work I always pick the ones with the lowest expenses.  Vanguards are the best and this one is only .05%.  The fund looks to track the performance of the S&P 500 Index.  It is a passive fund that looks to replicate the index.  So as the index shifts in sectors so would this fund. 

The admiral fund (VFIAX) was created on 11/13/2000 according to their website.  Unfortunately this has been a rough decade for the stock market.  Therefore any of my forecasts we will be using the dismal return rate since inception of 4.77%.  But don't forget on top of that is that expense of .05% each and every year.  For simplicity I will just knock that off the top and we will use 4.72% as the return each year.

Using the www.buyupside.com calculator this is what the portfolio would look like when I reach age 80.  For withdrawal I am using the fixed dollar amount of $23,231.  This would not be enough for my family and I to live off of but is still a nice chunk of change.  I will explain where that number came from later.

Starting Balance
$1,000,000
Annual Rate of Return
4.72%
Annual Withdrawal
$23,131
Annual Inflation Rage
3%
Number of years withdrawing
40
Balance after 40 years
$2,187,405

So if I were to collect one million dollars and buy into an index fund when I turn 80 I would have a little over 2 million dollars left.  This isn't bad at all and if I live another 10 years to the ripe old age of 90 it would grow a little more and I would be able to leave a sizable inheritance to my kids.  Now they couldn't live off of it for their whole lives since I would have to divide it among my 4 kids equally.  It would give them something to kick start there FI quest though.

VS. The Dividend Champions

Bring in the Dividend Champions.  If I were to take that money and buy a little of each company in the list (about 107 companies) and collect the dividends it would be about $23,131.  I just took the average price of 65.28 of the stocks which would buy me about 15318 shares.  Now the average dividend for the champions is $1.51 per share.  This is where I got the $23,131 in annual income that I mentioned above.  In the calculator I bumped the rate of return back up to 5.01% (See Dividend Life's comment  below) as any commission would be a onetime thing and would be negligible.  I did have to withdraw something for the calculator to work so I figured one dollar for a soft serve at one of the companies I would own would be a good treat.

Starting Balance
$1,000,000
Annual Rate of Return
5.01%
Annual Withdrawal
$23131
Annual Inflation Rage
3%
Number of years withdrawing
40
Balance after 40 years
$2,688,268

Boy look at that nest egg when you don't take from it.  I didn't even factor in the dividend growth rate which is averaging  7.9 percent for the champions.  This well offsets inflation and would give me either an ever increasing check every year or money to put back into buying more stocks.  Regardless when I pass my kids would each have there own million dollars to do the same for them and their kids.  The cycle would continue indefinitely because of the power of dividends.  This assumes I do a good job of teaching my kids about investing and living below your means.  It is a little more and the dividend growth rate would help boost the return rate if I put any thing above the 23k back into the market.  Still it shows the power that diviends have on returns.  A little more to give to the kids to help them along will grow for them over the years.

So if I had a million dollars I would take care of business myself and choose option 2.  Why chase the roller coaster that is stock prices when you can have the income dividends provide.  The dividend champions have been giving back the stock holders for 25 or more years.  That definitely lowers the risk that this stream of income would ever be cut even during bad years.  So why do others choose bonds or just go for stock appreciation?  I for one and sticking with the div machine.

What option would you choose?

*Updated option 2 thanks to comment by Dividend Life

8 comments:

  1. If volatility is a concern then there is always rental real estate. You don't get a daily price quote and still get monthly streams of income. I prefer stocks, especially the dividend ones since you don't have to utilize leverage. Do you think $1 million will be enough?

    Cheers.

    ReplyDelete
    Replies
    1. Morning Henry,
      Right now I live off of 65K. Off the top of my head when I get my house paid off I probably could live off of the income it would produce. Good idea for an article though!
      Later,
      DFG

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  2. Hi DFG,

    I was listening to that song last week too! Though I won't be buying an emu or a Garfunkel :)

    I like the calculator but I am a little confused here by your comparison to be honest.

    The VFIAX pays a 2% dividend yearly and that's factored into the 4.7% annual return so that's approximately 2.7% capital gain + 2% dividend gain.

    Now 23K is a 2.3% dividend yield. So I think, when you show the Champion case with a 4.7% total return and a $1 withdrawal, you're essentially saying that the Champion case has a 4.7% capital gain plus a 2.31% yield for a total return of 7.01%

    I have no idea of the capital gain difference between the Index and the Champions, but it might be a closer comparison to calculate the Champion case with an Annual Rate of Return of 2.7 (capital gain) + 2.31 (dividend gain) => 5.01% and a withdrawal amount of $23K. This still gives a higher number than the Index with $2.68M but it's probably a closer comparison.

    That said, the benefit of the Index fund is that it's less risky because it's more diverse (500 stocks vs. 107). Over a 40 year timeframe the Index might result in a higher total return since some of the 107 companies might go bankrupt or stop paying dividends. Or, the 107 companies could outpace the S&P and have higher total return than the index - that's the game: Risk vs. Reward.

    Thanks for the post though - it made my brain cell think and that's always a good thing!

    Best wishes,
    -DL

    ReplyDelete
    Replies
    1. DL,
      Thank you (really)...in my newbieness I had forgotten that dividends are included in the annual return rate. You are absolutely right...diversity or higher return. Always a tough call.

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  3. DFG,

    I have some funds in fund only accounts, but I prefer the dividend stocks by a wide margin. Too many hidden costs in actively managed funds. Some low cost index funds are good if you are not comfortable doing the work it takes, but I would rather pick my own stocks and win or lose then someone a I don't know doing it. Although some managers are pretty good a lot lag behind.

    ReplyDelete
    Replies
    1. Hey SWAN,
      What you said plus that is the fun part about investing...
      Thanks for stopping over.
      DFG

      Delete
  4. DFG,

    Nice face-off between index funds and dividend growth stocks, well done!

    I started off with ETFs, but switched to dividend stocks only last month. While I strongly believe in the dividend growth strategy, I believe the index option still is a nice option for people who don't want to put in too much effort, but want to enjoy a nice rate of return nonetheless.

    Currently I'm holding on to my index funds because of the diversification they offer me while I build my dividend portfolio.

    Cheers,
    NMW

    ReplyDelete
    Replies
    1. Good idea Waffles. My portfolio is small as well and will take time to get up to 50 or so companies. I really haven't given much though yet as to how many is to many for me to manage. I just see allot of others doing 50.
      Regards,
      DFG

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