Investment Income

Finance theory is clear: After taxes, you should be agnostic about the source of your cash flow.  It doesn’t matter whether you get cash flow (or investment income) from dividends, a coupon, or the sale of a security.  Dividends aren’t guaranteed.  Firms that pay them can and do cut the dividend.  Or they may kill it altogether!

You also need to consider interest rate risk.  What happens when you have a 10-year bond paying a 5% coupon maturing in 2012, and a recently issued bond, similar in all ways—term, risk, profile, etc.—that yields just 1.6%? In this scenario, unless you buy junk-rated bonds (increasing your portfolio risk, which may or may not be appropriate), you probably aren’t getting much yield.

There’s nothing wrong with getting cash flow from dividends or bonds, but you shouldn’t assume they’re risk free.  And you shouldn’t be shackled to them. 

Homegrown Dividends

If you need cash flow from your portfolio, and you don’t want to be stuck in an inappropriately large allocation of high-dividend stocks and/or fixed income investments, what can you do? You don’t want to sell securities, do you? 

Sure! Why not? That’s what they are there for!  This tactic we call homegrown dividends and it just means harvesting your portfolio however appropriate while remaining optimally invested for income.  And to do that, you can sell securities. 

Folks often say, “But I don’t want to sell principle.” But buying and selling individual securities is incredibly cheap—there’s little impediment to keeping your portfolio optimally invested based on your benchmark and selling securities now then to raise cash. 

Raising homegrown dividends also lets you do some tax planning, if appropriate.  You can sell securities at a loss, if you like, to offset some gains.  Some years you might not be able to do that, but even so, selling stocks with a long-term capital gain results in a relatively small tax liability.  And maybe you have loss carry-forwards to mitigate some of that.