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Growing vs. Spending

Saving for financial independence has two phases: growing and spending. During the growing phase, you are just trying to accumulate as much wealth as you can as quickly as possible. At the beginning, it will be many years before you need the money. Because you are saving for the long term, you can handle the ups and downs and ride out any downturns. Therefore, you should be 100% in stocks at all times. As you get closer to your goal, you have a decision to make: stick with all stocks or start diversifying.


If you are flexible in your timing, you could decide to stay 100% in stocks and just delay your plans until the market recovers in case of a downturn. On average, the worst stock market drops (called bear markets =~ 30% drop) last about 13 months and take 22 months to recover. Stock market corrections (=~ 10% drop) last about 4 months and take 4 months to recover.


If you have a hard target date (such as a child starting college), then you cannot tolerate the risk of a down turn. So to be safe, once I was within 3 years of my target date and I was not already in a market downturn, I would start shifting part of my savings to something more stable like bonds or even money market funds. The problem is that a more stable investment mix will most likely earn less of a return. If your current savings rate will not meet your target number with the lesser return, you may have no choice but to remain in your riskier investments.


As you get closer to your goal, you need to convert your growth investments into income generating investments. Remember that you will have to generate income from the after-tax proceeds from the sale of any growth investments. The other thing to keep in mind is how long you need to make that money last. If you have a relatively short finite time limit such as 4 years for college costs or 7 years until a pension or tax-deferred age limit, then you can consider withdrawal rates that steadily spend down your principal. This can substantially lower the amount you need to save to reach these goals.


If you need the money to last 20 years or more, it would be much safer to plan for a withdrawal rate that can be sustained indefinitely. In addition, if your withdrawals can be completely funded through dividends, you can ride through downturns without having to sell at a low point. However, you have to keep careful track of the company financials to make sure you are able to sell before any dividend cut and subsequent price drop.


There are a few companies paying 8% (as of 2/1/2019) that I believe are sustainable. If you really want more income, there are REITs paying over 16%, but each point over 8% represents quite a bit more added risk. For example, WPG has a current yield a bit more than 17% (as of 2/1/2019). WPG is in the business of owning second tier malls. These are malls without a significant big name draw and relatively lower foot traffic. Their anchor stores are going bankrupt or closing and over the last 5 years the stock has dropped from about $20 to less than $6. This makes their dividend appear unsustainable and I would not be surprised to see a dividend reduction announcement soon.

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