Can ROC Be A Retiree's Best Friend?
The other day I wrote about the extent to which an ETF that includes return on capital (ROC) in its payout can play a role in a withdrawal strategy from a taxable account where the expected outcome is that the taxable account gets depleted over some number of years as the IRA and Social Security both continue to grow.
When a fund can't meet its expected payout through dividends and/or interest it often will return capital to meet the total payout. This is more common in closed end funds (CEFs) than ETFs but the ETF profiled in the above linked post also returns capital. A colleague reminded me that ROCs are not taxable, they are returns of your capital; not taxable.
The common view with ROCs is to poo-poo them as a negative thing, I have certainly been negative on them before but in this context of expecting to deplete a relatively small taxable account (relative to an IRA) in a few years ROC may not be a bad thing they might actually be a good thing because the payouts are probably going to be steadier and again, ROCs are not taxed. Consult a CPA for tax implications.
So with funds with high payouts that might include ROCs the question becomes how well or how long they can stay ahead of their payouts. The risk is that a fund with too high of a payout could erode very quickly. Consider the following chart;
It tracks six CEFs over the last seven years which is a useful period in the context of the previous article which tried to get six, maybe seven years of living expenses without drawing from qualified accounts and letting Social Security grow. I got the first four CEFs from an article at Seeking Alpha by Stanford Chemist (anonymous blogger?), those four scored well in his screening process. The other two, MIN and PPT have been around for decades and I think are fairly well known. I often talk about closed end funds' tendency to move from the upper left to the lower right on a price basis due to not fully keeping up with their payouts and this chart supports the notion. In an account expected to sustain, this sort of price action is problematic but not so or at least less so for an account expected to deplete (great if it doesn't).
Someone allocating an equal $33,500 to all six funds in 2011 (so $201,000 not $200,000 for easier math) just taking the payouts and not selling any shares would have $162,211 in the account today after having collected approximately $101,000 in "dividends." So obviously the total return was positive but the account balance would be lower than where the account started by virtue of spending the entire payout.
The original premise of spending down $200,000 in six years though means spending $33,000 per year, hopefully squeezing out a seventh year if the return is enough. Only taking out the $101,000 in "dividends" would work out to just $16,800 per year. Adjusting then for taking $33,000 per year starting in June 2011, the original $200,000 would now stand at approximately $31,000 which is almost enough for an eighth year of income which means an additional year of letting the qualified accounts possibly grow and maybe allowing Social Security to grow, depending on when you assume the 70th birthday. To get to that number I assumed selling the top performers first, holding on to the worst funds the longest figuring the most negative bias I could. Selling equal dollar amounts from each fund every year would mean a little more left over than the $31,000 but I did not do that math.
Also, remember the hope was trying to get six years at $33,000 per year before the account went to zero but getting eight and of course most of the funds are down dramatically on a price basis. While the result of this exercise isn't necessarily earth-shattering it is nonetheless a plausible scenario, remember from the other linked post there is an IRA that started at $700,000 that might now be a $900,000 (assuming half the equity market growth of what actually has happened this decade) and Social Security has been allowed to max out.
I don't want to gloss over the fact the closed end funds are very risky but of the six funds we chose, only one is up on a price basis (and that was assumed to be sold first), one of the funds might be thought of as being down moderately, the rest are down a lot so the exercise bore the brunt of the risk.
Finally, I still concede how emotionally difficult this might be and maybe instead of using all CEFs perhaps it makes more sense to have a mix of investment products with extremely high yields (and the risks implied) like BDCs, MLPs and mortgage REITs. If nothing else, this is very interesting.