Why I LOVE Dividends and Can’t Stand Index Annuities (2018)

Sequence of return risk is among the largest mistakes non-professionals and math-oriented investors make regarding personal financial planning.

These folks conflate AVERAGE investment returns with a annual, year over year, investment returns. And you just can’t do that.


S&P 500 Averages

Let me explain. You look at the S&P 500 and see that it has averaged say 10% a year since 1926. Thus you think if you invest in the S&P500 you can safely withdraw 6% a year and you will still add 4% a year to your capital base.

$100,000 in the SP 500 allows you to withdraw $6,000 and the next year you have $104,000 in your account.

Using average returns over time, this actually makes sense.


S&P 500 Decline 2000-2002

But reality isn’t ‘average’. In reality, the SP 500 has years like 2000, 2001 and 2002 when it was down 9%, 11% and 22% respectively.

In this case, your $100,000 fell to $91,000 in 2000. Then you withdrew $6000 and now your investment was down to $85,000.

The following year, your $85,000 fell 11% to be down to $75, 650 and once you withdrew your $6,000 you only had around $69,000 left.

In 2002, the portfolio fell another 22%, putting you down to $54,000 and when you withdrew $6,000 you were left with less than HALF of what you started with 3 short years earlier.


Not Sustainable Withdrawal Rate

Your $6,000 a year withdrawals are no longer equal to 6% like it was initially, but now you’re withdrawing almost 13% a year from your portfolio!

No amount of growth from here on out is going to save you. You WILL run out of money!

That is sequence of return risk. Even though the market averaged 10% a year, or whatever it was, in any year you could lose your shirt and thus your distribution percentage is WAY higher than can be sustained.

This is where the 4% rule becomes important to understand. Because it is the 4% rule that takes into consideration sequence of return risk.


Interest Rates Vs. Total Return

Second part of this video, I talk about how interest rates work vs. total return on bonds and bond funds.

Interest rates are simply what you get for investing your money into a bond TODAY. I buy a bond today that has a an interest rate(or coupon) of 6% for $100,000.

I will then receive $6,000 annually until either the bond matures and I get my $100,000 back. The issuer goes bankrupt, in which case I lose everything. Or the bond is called, kind of like a corporate debt refinance, and I receive the $100,000 back.


What Happens When Interest Rates Go Down

Now let’s say interest rates go down across the economy. That same issuer of the bond I hold now issues new bonds but this time they’re only paying 5%.

The new bonds also cost $100,000. So, if I were to buy a new bond for $100,000 I’d only get $5,000 a year in interest. Which do you think is more valueable? A bond paying $5,000 or a bond paying $6,000?

Well, the $6,000 bond is of course.

This means my $6,000 a year bond will command a higher price than the bond that only pays $5,000.

But remember I paid $100,000 for each bond. So, in this case, my 6% bond could be sold for MORE than $100,000 because an investor would be willing to pay a premium on that bond in order to get more interest.

The investor says something like, “I can pay $100,000 to get $5,000 a year interest, or I can pay $105,000 to get $6,000 a year interest.”

(There is a mathematical formula to determine the actual value for the 6% bond by the way.)


Capital Appreciation on Bonds are Not Sustainable

Let’s say I sell my 6% bond for $105,000. Now I’ve made $5,000 in capital gain AND $6,000 in bond interest for a total return of 11%.

Whereas if I didn’t sell the bond, I’d just get interest of 6%. And that is the difference between the two.

But, critical to remember, my 11% total return is only temporary. I can not get 11% total return again. The only reason I was able to pocket that extra $5k was because interest rates went down. They can only go down so far


What Happens When Interest Rates Go Up

In fact, when they start going up again, my 5% will LOSE value because it’s only paying $5,000 when other bonds are paying $6,000.

In this case, I’d take a LOSS in order to sell that bond and that loss would offset the capital gain I had before.

Finally, at the end of the day, the ONLY return one can correctly assume he will earn on bonds is the interest rate he receives on the day he bought the bond.

All other returns, that go into the total return calculation are only temporary.

You can not rely on total return of bonds to estimate your potential for a bond investment. You should ONLY use interest rate at the time you purchased.

For more information on topics like this, visit my website at www.heritagewealthplanning.com

Dividends historically have accounted for nearly 40% of a portfolio value’s growth.

Even with the low dividend yields today, dividends still play a HUGE role in growing the net worth for investors.

In this video I show you exactly how dividends improved the performance of the Vanguard S&P 500 fund (VFINX) by 50% from 2003 until March 2018.

I compare the PRICE ONLY performance of the VFINX to the price + dividend performance.

Price only performance increased an initial $100k investment to $297k. Yet, dividend reinvestment increased that $100k to $406k at then end of those 15 years time.

Don’t forget this is in a low dividend yield environment too. In fact, after 2008 many of the higher dividend paying companies, banks come to mind, STOPPED even paying dividends.

Yet, the numbers speak for themselves; Dividends added 50% more growth than just price.

The interesting thing is that if you look at index annuities, they don’t use dividends in the returns investors get! Add on the hefty fees and it’s next to impossible for an investor to get anywhere near a market like return. Just can’t happen.

No dividends PLUS high fees = VAST under performance. Which is why I recommend staying away from these types of “investments”.

If you want “safety” there are better alternatives.

If you want “growth” there are better alternatives.

If you want a combination of some safety and some growth there are better alternatives. In future video’s I’ll discuss the alternatives.

But for now, just watch this video and allow me to show you EXACTLY how dividends are just so important to your financial well-being.

© Copyright 2018 Heritage Wealth Planning