I was listening to a @moementumfinance podcast where part of the discussion treated the percentage of distributions being reinvested almost like a dial for risk. ⠀ In some ways, it is. Reinvesting more means spending less, which lowers the withdrawal rate and reduces the risk of depleting the portfolio. ⠀ But I think that framing bundles together a few different concepts: the percentage of distributions being reinvested, the actual portfolio withdrawal rate, and the risk of the underlying strategy. They are related, but they are not interchangeable. ⠀ The percentage being reinvested only tells us how much is being spent relative to the distribution. It does not tell us how much is being spent relative to the portfolio. ⠀ If a portfolio yields 10% and you reinvest 60% of the distributions, you are withdrawing 4% of the portfolio. If another portfolio yields 20% and you reinvest the same 60%, you are withdrawing 8%. ⠀ The dial is set to the same place, but the portfolio is being asked to support twice the withdrawal rate. ⠀ The familiar 4% rule provides some useful context here, although I think it is often misunderstood. Bengen was not saying retirees should recalculate 4% of their current portfolio value and withdraw that amount every year. He was looking for a maximum safe initial withdrawal rate that could survive the worst historical 30-year retirement period in his data, with the initial dollar withdrawal adjusted for inflation in subsequent years. ⠀ Roughly 4% was therefore closer to a worst-case historical benchmark and rule of thumb than a claim about what every retiree should spend. Different portfolios, time horizons, spending methods, and assumptions can reasonably produce higher or lower numbers. ⠀ The useful part of the framework is the direction of the question. It starts with the total portfolio and asks how much consumption it could have supported through some very difficult historical conditions. It does not start with the portfolio’s yield and assume that some percentage of the distributions must be safe. ⠀ How much you can sustainably withdraw is ultimately a function of your strategy’s total return and risk, not simply its yield. ⠀ The reinvestment percentage is a real lever, but only after the distribution has been translated into an actual withdrawal rate. Saying that reinvesting 60% is conservative tells us very little without knowing whether the portfolio is distributing 6%, 10%, or 30%. ⠀ It can also encourage the idea that yield itself can be dialled up or down to fit the investor’s needs. If the portfolio is smaller or more income is needed, choose a higher yield. Once the portfolio is larger, move into something yielding less. ⠀ But a smaller portfolio does not need a higher yield. It has a higher required withdrawal rate. ⠀ Choosing an investment that distributes enough cash to cover that requirement may make the mechanics easier, but it does not change the underlying math. If you need $100,000 from a $1 million portfolio, you are consuming 10% whether the portfolio distributes 5% and you sell another 5%, distributes exactly 10%, or distributes 20% and you reinvest half. ⠀ Distribution yield also does not tell us how much return the portfolio has actually generated. A distribution might come from dividends, interest, realized gains, option premiums, return of capital, or some combination of them. Those sources can have very different implications for future returns, taxes, risk, and the value of the remaining portfolio. ⠀ This matters even more with extremely high-yield strategies. A larger distribution does not necessarily mean the portfolio is producing a larger economic return. Reinvesting part of that distribution may help offset a decline in value, but it does not prove that the amount being spent is sustainable. ⠀ The portfolio still has to generate enough total return, with an acceptable path of returns, to support whatever is being consumed. That path matters because two portfolios with the same average return may support very different withdrawals if one experiences deeper losses, greater volatility, or poor returns early in retirement. ⠀ Distributions can still be useful for cash-flow planning. Some investors may prefer strategies that deliver more cash, reduce the need to sell units manually, or provide psychological comfort during volatile markets. Those are all legitimate preferences. ⠀ They are just separate from the sustainability question. ⠀ The percentage of distributions being reinvested can be a useful personal rule, but it is not self-explanatory. Before calling it conservative or aggressive, we have to translate it into an actual portfolio withdrawal rate and ask whether the strategy’s total return and risk can reasonably support it.
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13 Comments
TQ @tqrad888 · 12h
Excellent post Kar! Hopefully people can understand the concepts and realize the differences between the various terms like distribution rate, reinvestment rate and withdrawal rate etc. And hopefully people can realize the potential consequences if an investor surpasses the safe withdrawal rate over the long run, depending on what happens with markets and their investments over the next many years to decades. Math is math!
CoderDonna @coderdonna · 14h
Some "never thought about this" questions. So, to get the total yield of my portfolio, I would look to see...what percentage of dividends it throws off annually? Or add in what profits were made annually too? I've never considered the question this way. My goal for my dividend stocks has (and is) to reinvest until each dividend (regardless of schedule) is enough to buy another share (more or less, given price fluctuations). Then, at some point, I would start taking some of the dividends, but not all, so the underlying stocks would stay sustainable. But given that I don't truly understand the yield situation, I'd like to figure that out, too. This may be totally an apples and oranges question, I have obviously not organized my thoughts very well. Apologies for that, but I would appreciate any guidance on how to understand this concept. Thank you in advance!
Ian S@ian_s · 1d
This kind of post is the best kind! Thanks for showing the reasoning at work. 👍 really enjoyed this one Kar.
Moe @moementumfinance · 1d
Really interesting perspective and a great way to look at it. I think that is why even for a portfolio that has a modest 2% annualized distribution yield, if the goal is to withdraw 4% from the portfolio, that translates to withdrawing a 2% from the portfolio besides the 2% distribution yield (i.e. 2% plus 2%), as opposed to assuming you can use the distributions and then still withdraw 4%, and assume the total withdrawal from the portfolio is still 4%.
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