How to Get Income Without Dividend Funds

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If want something done right, do it yourself. But does this old proverb apply to dividends?

Dividend stocks to buyAs investors, we are trained to believe that the best way to get income through equities is by finding and investing in the best dividend stocks or buying and holding dividend funds.

But if you reexamine this logic and think outside the box, so to speak, you might return to the most fundamental question:

What are dividends?

In simple terms, dividends are cash payments made regularly to shareholders by a company from its profits.

Now return to the idea of doing it yourself.

To remove the need to rely on a company to decide what dividends it will pay, and thus remove the need to research and buy dividend stocks or dividend funds, you simply pay cash to yourself on a regular basis out of your own profits.

So, how do you structure a portfolio to become a dividend-producing vehicle without actually owning any dividend funds?

Create Your Own ‘Dividend Payout’ With a ‘Three-Bucket System’

When creating a portfolio designed for income, without relying exclusively on bond funds and dividend funds, you need to do a sufficient job of balancing the three primary investment objectives:

  1. Preservation
  2. Income
  3. Growth

Therefore, to make portfolio management both simple and effective, you will implement a respective three-bucket system: One bucket will consist of cash, a second bucket will consist of bond funds and core stock funds, and a third bucket will consist of aggressive growth stock funds:

  1. Bucket 1: All of your periodic payments (self-created dividends) will come from this bucket. Here you will want to keep one to three years of needed (or desired) income in cash with money market funds or similar liquid vehicles. The one- to three-year time frame will help ensure that you will not need to sell shares of bond funds or stock funds during a major correction. The average bear market duration is less than one year.
  2. Bucket 2: This bucket will feed Bucket 1 when more cash for payouts is needed. Investments here will include a balance of bond funds and core stock funds, such as a large-cap index fund.
  3. Bucket 3: This bucket is where you will reach for the highest returns with a diverse mix of high-relative-risk/high-relative-return funds from fund categories such as small-cap stock, mid-cap stock and foreign stock. This bucket will feed Bucket 2, with sell-side trades hopefully taking place only in up markets.

The idea of the three-bucket system is to choose your own income payout, which will be just the amount of income you need — not more, and not less. Also, this system is more tax-efficient compared to one that relies on dividend funds.

While dividends are generally taxed at a lower rate than ordinary income, they are less tax-efficient than capital gains, because you are taxed on dividends in the year in which they are paid, but you are not taxed on capital gains until you sell the stock. This further supports the three-bucket approach — you are making your periodic withdrawals from cash and only selling shares of stock funds or bond funds when necessary to feed Bucket 1.

For another tip on tax-efficiency, if you have a combination of taxable accounts (i.e. individual and joint brokerage accounts) and tax-deferred accounts (i.e. individual retirement accounts), it is preferable for tax-efficiency reasons to have “Bucket 1” money in taxable accounts and the other buckets in the IRAs.

Dividend funds certainly aren’t bad, but if you’re looking for an alternative from the norm, this payout system at least provides a couple of unique benefits.

The information in this story is provided for discussion purposes only, and should not be misconstrued as investment advice. Under no circumstances does this information represent a recommendation to buy or sell securities.


Article printed from InvestorPlace Media, https://investorplace.com/2014/09/get-income-without-dividend-funds/.

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