Investment Growth

An Analysis of the Thornhill Method — Part 1: The Dividend Delusion

Posted by on 5 May 2019 in Investing & Asset Allocation

If you’ve been hanging around financial independence forums, you might have noticed two competing approaches to financial independence.

The first advocates accumulative a large portfolio of shares and sell those shares as income during retirement. And the second — known as the Thornhill Method — advocates accumulating a growing dividend stream and living off dividend income during retirement.

You may have noticed that there is a growing number of people advocating the Thornhill Method. It makes sense. The approach is quite intuitive and easy to understand, and seemingly overcomes challenges with the original approach to financial independence (e.g. sequence of returns risk).

However, there hasn’t really been a serious, objective analysis of the Thornhill Method and its implications for retirement. It’s a big topic, so in this first post we’ll take a deep dive into dividends to compare dividend income and selling shares for retirement income.

What is the Thornhill Method?

In it’s simplest form, the original approach to finance independence suggests that we should accumulate a large portfolio of shares and sell those shares as income when we retire. As long as we sell fewer shares than our safe withdrawal rate, that nest egg should last us throughout retirement.

The Thornhill method is an alternative approach to retirement income. The three main components of the approach are:

  1. Dividends are preferable to capital growth. Instead of accumulating assets and selling those to fund our retirement, we should accumulate a portfolio with a growing stream of dividends and live off the dividends during retirement. No selling shares needed.
  2. Industrials are the best source of dividends. We should aim to purchase high yield shares in the industrials sector, as they provide the most reliable and consistent dividends.
  3. Purchasing LICs is the best way to access industrials dividends. We don’t need to pick individual high yield shares, as purchasing LICs gives us a diversified portfolio of high yield industrials shares.

If you want to learn more about the approach, I suggest checking out Peter Thornhill’s website and interviews with Peter by StrongMoneyAustralia and RetireOnDividends.

There is no difference between selling your shares and living of dividend income during retirement

The big argument that we regularly hear from Thornhill die-hards is that dividend income is somehow better than selling your shares to fund your retirement. In fact, the following quote is from Peter Thornhill himself (via StrongMoneyAustralia):

If, however, you are cashing shares to supplement your income you will be exposed to the fluctuations in share prices which may see you selling shares at a less than ideal time…. GFC anyone?!

Eating the seed corn is how civilisations implement Darwin’s theory by self-selecting themselves out of the human race.

Ouch! At first glance, this feels like a very compelling argument. Why would you want to sell your shares during a bear market? You’d have to sell more shares to maintain your income (as their price is lower) and you’d be locking in losses.

But dig a little deeper and you realise that there’s a fallacy at play.

Here Thornhill is saying that we’d be worse off selling our shares during a market drop, so the counterfactual is that we’d be better off (i.e. achieve better returns) with a dividend-based strategy. In other words, Thornhill is contrasting column 1 with column 2 in the chart below.

Let’s conduct a thought experiment. Imagine that we invested $1,000,000 a company called Dividend Ltd and $1,000,000 in a company called Growth Ltd. These companies are identical in every way and they grew by -4% in the last financial year. This means we’d have portfolio loss of $40,000 in each of our companies.

In addition to that, we need $60,000 to live off for that year of retirement. Dividend Ltd will pay $60,000 in dividends but we’ll have to sell $60,000 worth of Growth Ltd shares to fund that year of living.

Here’s the dodgy math. People mistakenly believe that the total loss of Dividend Ltd is $40,000 (capital loss) but the total loss of Growth Ltd is $40,000 + $60,000 (capital loss + selling of shares). They forget that dividends have to come from somewhere!

This is how it actually works:

The missing piece is this: if Dividend Ltd pays out a dividend, that is reflected as an additional capital loss (we will illustrate this phenomenon with actual Wesfarmers data in the next section). So in the example above, both Dividend Ltd and Growth Ltd have a final portfolio value of $900,000. This is correctly contrasting column 1 with column 3 in the earlier chart.

Unfortunately, Mr Thornhill does not seem to recognise that selling part of your portfolio at a market dip is no different than not re-investing your dividends in the dip!

Any ‘benefit’ of dividends is immediately arbitraged away

In the last section we explained that there is no difference between dividend income and selling shares as income. Now we’ll show how this works in practice.

In the real world, if there was some incremental benefit for holding high yield shares, that benefit would immediate be arbitraged way. Otherwise, it would make no sense for investors to hold anything but high yield shares.

For example, the market would immediately start selling off capital growth stocks (thus pushing the price down) and purchasing high yield shares (thus elevating the price). At some point, the market would reach a price that reflect the total value of each type of share. And there we have the efficient market.

We can actually see this in the real world! The chart below shows the movement of Wesfarmers’ share price around their 2018 final dividend. Westfarmers announced their 2018 final dividend of $1.20 overnight on the 14/15 August. This signaled that there is additional value in owning Wesfarmers shares, so investors purchased the share and drove up the price to reflect this additional value.

Generally speaking, the price increases by approximately the value of the dividend. In the case of Wesfarmers, the price shot up by $1.38 then landed $0.89 above the pre-dividend high. There are a bunch of potential reasons why it didn’t exactly land on +$1.20, including:

  • natural variability in the day’s trading
  • the fact that Wesfarmers dividends are regular and investors may have partly ‘priced in’ or assumed a dividend was coming even before it was announced
  • that Wesfarmers financial results were announced on the same day and other factors may have put downward pressure on the share price

But the important point here is that, once the dividend is paid, the price then plummets back to pre-dividend levels. This means that the owner of the share cannot have their cake and eat it too. They can either receive the dividend and suffer the immediate drop in capital growth, or they can sell their share and lock in the capital gain, but not receive the dividend.

Even if dividends were somehow ‘better’, they can still be cut!

The last thing we need to keep in mind is that dividends are not a sure thing. Dividends are distributions of company earnings. When times are tough and companies aren’t earning, they can (and do) decide to reduce their dividends.

That’s exactly what we saw during the GFC. If you were living off dividends at the time, you’d be in for quite the shock. In the table below, we calculate divided income for Wesfarmers through the GFC and beyond. Note that we adjusted the required retirement income to grow at inflation.

Although dividends would have covered our required income before the GFC, they certainly fell short during the GFC. In fact, on an inflation-adjusted basis, even 11 years later they haven’t fully recovered and are still short by 20% of what we need during retirement.

In short, dividends are not a guaranteed income, they don’t always keep up with inflation, and it can take an extremely long time for them to recover to their previous peak. It would be tough to survive years on an income level below what you require.

You may argue that Wesfarmers could just be an outlier with particularly high cuts to dividends and that’s a fair argument. But take a look at this RBA research paper. ASX total dividends were cut significantly during the GFC and didn’t recover for three years. And it looks that those figures aren’t inflation-adjusted, so they likely didn’t recover in real terms for even longer.

And yes, I know there are a bunch of people yelling “what about LICs!?”. It’s true that a number of LICs didn’t significantly cut their dividends during the last financial crisis. But there’s a good explanation for that, which I’ll leave for the next post that focuses on LICs.

Are you still clutching onto the dividend delusion?

There is one way to put this debate to bed once and for all: run a simulation.

For this exercise we simulated total portfolio returns for an Australian ASX300 index fund (VAS) and an Australian high yield index fund (VHG). As far as we can see, VHG is the only extant high yield fund that was around pre-GFC.

The chart below plots indexed nominal returns (i.e. not adjusted for inflation) with dividends reinvested from immediately pre-GFC (May 2007) to today.

As you can see, there is little difference in the performance of the high yield fund when compared to the ASX index fund. The high yield fund did outperform the index fund from 2011-14 and then the index fund outperformed from 2014-18. These performance differences are most likely due to inherent differences in the underlying assets in each fund (e.g. the different sector mix). In any case, we don’t see the high yield fund consistently and reliably outperforming the index fund.

It is particularly noteworthy that there is almost no difference in the performance of the funds during the GFC (2007-09), which clearly illustrates that that there was no incremental benefit of dividends over capital growth even during a bear market.

But dividends aren’t bad, they’re just not better

To be clear, there seems to be nothing wrong with a dividend-based approach to investing for financial independence — it’s just no better than a capital growth-based approach.

Instead of trying to split hairs between dividends and capital growth, it makes more sense to measure total returns (i.e. capital growth plus dividends). And when we view the numbers through the total returns lens, we don’t see much difference between each approach.

As we mentioned earlier, Thornhill advocates purchasing LICs in lieu of individual high yield shares. On face value it looks like LICs don’t suffer from some of the same challenges as we described above, so in the next article we’ll take a closer look at LICs and whether they are a better alternative as a means to financial independence.

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There are 45 comments on this article

  1. Avatar for Dan Montgomery


    Good article, and lots more to debunk, which I’m sure you will get to in future posts, including but not limited to
    – LIC’s being able to have a lower reduction in dividends being due to holding more safe non-earning assets
    – The mining sector data manipulation where he uses the starting date at which the mining sector had one of the biggest booms in history and was massively above its historical mean and then “shows” that mining under performs by using data where it obviously would revert towards it’s long running mean, which turns out to be extremely close to the rest of the market.
    – Saying mining is bad because it doesn’t pay out dividends as though you can not sell down yourself.
    – Saying REITs are bad because it pays out too much of it’s dividends as though you can not re-invest them yourself.
    – Saying active management is better than indexing because you can’t exude the lower quality companies, despite the overwhelming evidence against it.
    – Saying international is bad because Australian companies sell a lot overseas (as though that somehow is equal to diversifying into the other 97.5% of the worlds companies)

    The only thing I disagreed with in your article is when you said:

    To be clear, there seems to be nothing wrong with a dividend-based approach to investing for financial independence — it’s just no better than a capital growth-based approach.

    There is indeed a problem with the dividend approach, which is the concentration risk it introduces. To get 4% in dividends, you would end up investing in a severely concentrated market, adding idiosyncratic risk, which is a risk without a corresponding added expected return.

    Adding more assets that have a higher risk and corresponding higher expected return (equity over fixed income, small caps, value stocks, emerging markets) makes sense if it fits your risk profile, but adding idiosyncratic risk without reward makes no sense.

    • Avatar for Dan Montgomery

      Dan Montgomery

      Thanks for your considered comments mate. You make some great points, it might be worth spending more time on idiosyncratic risk in the next post!

      • Avatar for Dan Montgomery

        Peter Thornhill

        I have never talked about high yield shares; this is an assumption you have made.
        Read my comments on the yield trap; our best income shares are the lowest yielding.

  2. Avatar for Dan Montgomery


    Great post as always. And some well considered points.

    The other thing that is difficult to work in to the scenarios is taxation handling and its effect on returns. Dividends obviously being taxed at the marginal rate along the way. Capital gains tax is obviously up for change shortly and of course franking credits.

    So the numbers may be very different in 12 months times, never mind 10-15 years time.

    • Avatar for Dan Montgomery

      Dan Montgomery

      Tax is a tricky one, as it depends on your individual circumstances and it’s a moving target at the moment (e.g. franking credits). I’ve purposely avoided tackling taxes for now.

  3. Avatar for Dan Montgomery

    Dave @ Strong Money Australia

    Hi Dan. As a dividend investor myself, there’s a couple of things I’d like to explain the thinking behind – not to ‘prove’ anything, just to offer some thoughts. I’ve enjoyed your blog posts so far, and I hope this doesn’t come across the wrong way 🙂

    Firstly, I’m not sure where the ‘high yield’ focus is coming from? Thornhill doesn’t mention this as the goal as far as I’m aware, and I haven’t suggested high yield shares are the target either. This is a common misconception.

    On the second point, it’s also never been implied (as far as I know) that dividend paying shares will achieve higher returns in a bear market, or any market. The preference in the bear market is perhaps based on company dividends tending to fall less than market prices. So the investor’s income is more tied to business profits than market sentiment. That’s where the preference comes in I think.

    The ‘dodgy math numbers’ assumes a rational market that will value cash on the balance sheet equally at all times – that seems unlikely in a bear market. I’ve never seen a dividend investor believe that dividends are free money and the share price doesn’t rise and fall around dividend dates.

    This doesn’t mean it’s fake money either. It’s company cash which has built up from company earnings. It seems reasonable that shareholders get a decent amount of this paid out to them as there are numerous examples of companies blowing the cash on bad acquisitions trying to chase growth or spending it unwisely in other areas. A commitment to dividend payments force the company to spend more carefully.

    To suggest a dividend approach makes no difference in a bear market or any market because total returns were similar might miss the bigger picture I think – that the goal of a dividend investor is not a ‘high yield’ but a relatively reliable (within reason) income stream which grows over time, and share prices can do what they like. Much like a property investor who simply wants to collect a rental stream which grows over time, and doesn’t really care what they’re worth. The investor is simply interested in the cashflow from the assets.

    Also never seen it said or implied that dividends are guaranteed. Picking one company to illustrate nasty dividend cuts is fine, but it hardly disproves the strategy. Who’d hold one individual stock and live on that? CBA dropped the dividend for one year and the following year was higher than before. In any case, you’d likely hold a big spread of companies which helps mitigate that risk somewhat.

    The GFC was also quite unusual, with dividends growing by around 15% per annum for the 5 years leading up to it. I’d hope any sensible investor would realise that was way too good to be true, not be banking on that continuing and hold a decent amount of cash for the times when dividends are cut.

    In regards to VHY, again we’re back to the ‘high yield’ thing. Haven’t seen Thornhill recommend this as he doesn’t like ETFs generally. I don’t think it’s a product where the income would be all that reliable, and the fluctuations in yearly distributions show that.

    Just to be clear, I’ve never said it’s better than any other approach. More that it just suits me better, is how I like to invest and am more comfortable with at this time. Maybe that’ll change, who knows. But it hardly seems like a delusion or crazy preference to me. Others will see it differently.

    Anyway, I hope these thoughts provide a little more context as to the mindset of an income focused investor. Cheers, Dave 🙂

    • Avatar for Dan Montgomery



    • Avatar for Dan Montgomery

      Dan Montgomery

      Thanks for the thoughtful response SMA. I’m more than happy for you to critique my ideas!

      If we agree that Thornhill prefers dividends over capital growth, then it follows that he prefers high yield shares over low yield shares. I can’t see how he can argue that dividends are preferable but then simultaneously not advocate for high yield shares. I also see this sentiment in his commentary/preference for industrials.

      “It’s also never been implied (as far as I know) that dividend paying shares will achieve higher returns in a bear market, or any market. The preference in the bear market is perhaps based on company dividends tending to fall less than market prices. So the investor’s income is more tied to business profits than market sentiment”.

      Again, this seems inconsistent. Is the contention here that dividends are more resilient during a market fall? If so, then we must believe that dividends paying shares will achieve higher returns in a bear market.

      “Total returns were similar might miss the bigger picture I think – that the goal of a dividend investor is not a ‘high yield’ but a relatively reliable (within reason) income stream which grows over time, and share prices can do what they like.”

      I understand what you’re saying but it’s a misconception. Efficient markets mean that there is no categorical difference between selling shares and receiving a dividend. Therefore, total returns is an appropriate lens through which to compare approaches.

      “Also never seen it said or implied that dividends are guaranteed. Picking one company to illustrate nasty dividend cuts is fine, but it hardly disproves the strategy. Who’d hold one individual stock and live on that? CBA dropped the dividend for one year and the following year was higher than before. In any case, you’d likely hold a big spread of companies which helps mitigate that risk somewhat.”

      I agree that looking at WES isn’t necessarily indicative of the entire market. But if you look closely at the RBA research paper I linked, you’ll see that dividends didn’t recover for three years in nominal terms. This means that in real terms, it probably wouldn’t have recovered for 4-5 years!

      “Haven’t seen Thornhill recommend this as he doesn’t like ETFs generally. I don’t think it’s a product where the income would be all that reliable, and the fluctuations in yearly distributions show that.”

      This is fair. I know that Thornhill advocates LICs over ETFs. The purpose of this article was to go deep into dividends. We’ll look closer at LICs soon!

      Thanks again mate and let me know if I’ve misunderstood anything 🙂

      • Avatar for Dan Montgomery

        Dave @ Strong Money Australia

        You’re still making a bunch of assumptions. I’m telling you that high yield is not the goal, from someone who follows this approach, so I’m not sure why you insist on telling me that’s what the strategy is.

        A high yield which doesn’t grow is next to useless. A high yield which grows slower than inflation is also next to useless. So a dividend investor is more concerned with owning a portfolio that has a balance of lower yield higher growth stocks and lower growth higher yield stocks. The goal is a decent yield which grows over time with inflation.

        Peter’s industrials preference is due to his distaste for the volatility of resources earnings and dividends through the cycle. As you can imagine, if one is reliant on this income, companies with less volatile earnings and dividends are more desirable. As a small example, BHP cut its dividend by 75% just a few years ago.

        Totally agree that dividends did not recover for many years, that will happen in a GFC or similar! A dividend investor has to have backup plans just like any other investor.

        • Avatar for Dan Montgomery


          a dividend investor is more concerned with owning a portfolio that has a balance of lower yield higher growth stocks and lower growth higher yield stocks. The goal is a decent yield which grows over time with inflation.

          Lets make it clear what you’re saying – that dividends equal earnings – otherwise they would not be able to sustain a growing distribution over time.

          Dividends are not earnings.

          But lets go with that idea anyway – that we are looking for companies that grow their earnings over time.

          Barring some sort of risk (manager risk, sector risk, country risk), as the earnings increase, so would the share price, so again the amount paid out as dividends are meaningless and arbitrary.

          What you are saying boils down to the idea of picking companies that will grow their earnings overtime. The goal of every investor, not just someone labelling themselves a “dividend investor”.
          The problem is in predicting the future for which companies are going to be able to sustain growing earnings over time.

          Dividend investors are notorious for using back testing and only including companies that intended to and survived their attempt to constantly increase dividends, and then using only the companies that survived, you show the out performance. This is survivorship bias. Include the ones that attempted to increase dividends over time and failed and the returns all of a sudden come back to the market average.

          Muddying the idea by confusing earnings with dividends and ignoring the idea that such increased earnings would otherwise pump up the share price to use to live off (often through buy backs), and leaving out the inherent problem of finding these companies in advance vs in retrospect is not a strategy to search and uncover the truth, it is a strategy to convince someone to agree with your point of view regardless of the truth.

          • Avatar for Dan Montgomery

            Dave @ Strong Money Australia

            Hmm yet more assumptions. If I meant what you’re saying, I would’ve said that.

            Dividends tend to grow over time as earnings increase, nothing new there. And yes, ideally, we want to own a broad group of companies which on average will increase their earnings over time.

            You can say it’s meaningless because the share price also grows – that’s fine, you can focus on one while I focus on the other. But this misses something.

            Earnings are valued by the market on a certain multiple, which fluctuates through the cycle. So a ‘share price’ watcher has to contend with the volatility of earnings plus the expanding and contracting earnings multiple. And we know this can change dramatically over the years, a market may trade for 18x earnings and a few years later 14x earnings, and vice versa. The investor who simply collects the income from their shares doesn’t have to worry about that extra layer of volatility, but yes it’s happening in the background.

            It should be noted that you can simply buy an index fund or a widely diversified LIC and live off the dividend flows, rather than try to find the best stocks. I’ve never said dividend investing outperforms or that this approach is about picking outperforming stocks. Instead, it’s mostly about the mindset of the investor and what they choose to focus on.

            It’s all a very circular conversation which has been had on the internet a million times over. I’ll just leave it there as I’m sure we’ve all got better things to do. I’m sure you’re happy with your approach and I’m happy with mine. All the best.

          • Avatar for Dan Montgomery

            Peter Thornhill

            Dividends are paid out of earnings. Ever heard of a ‘payout ratio’? This is the amount of the earnings paid out as a dividend. Earnings grow; dividends grow and yield remains largely unaltered apart from when sharp fluctuations in share prices intervene.

      • Avatar for Dan Montgomery

        Peter Thornhill

        Can I repeat, I DO NOT LIKE HIGH YIELD SHARES.

      • Avatar for Dan Montgomery

        Peter Thornhill

        Well Dan, how are people going cashing in shares for the capital gain to produce income. There’s obviously a few judging by the volumes.
        I’m so glad as I am nibbling away to soften the blow as dividends are curtailed during this increasingly difficult time.

        • Avatar for Dan Montgomery


          ^^ Boom. And here’s us collecting WHF’s stable dividend whilst the index distributions……

  4. Avatar for Dan Montgomery


    Hi Dan,

    Great post and subsequent comments.

    One of the most important aspects missing from the analysis is “behavioural” which is why a great many investors do poorly and struggle to stay the course. So regardless of whether an approach is optimal or not doesn’t matter as much as whether the investor can stick with it.

    Personally I’ve seen these debates a thousand times over the years but still choose to invest in equities for their “income”. It’s enables me to ignore volatile share price, removes selling decisions and should something happen to me my wife who has little interest in investing can get on with life knowing the money will continue to flow into the accounts with no action required on her part.

    But it’s important to note that I only invest in older style LICs / cap weighted traditional ETFs diversified globally as opposed to VHY, high yielding bank shares and the like. The concentration risk doesn’t apply.

    That said I suppose one could argue that in our case there is really no difference between investing for income vs total return except we are fortunate in that our level of wealth is enough to allow us to live off income alone.

    Which likely suggests that my comments other than the behavioural aspect might not be appropriate on Blogs focused on FIRE.

    • Avatar for Dan Montgomery

      Dan Montgomery

      I agree Nodrog. I think that there are indeed some behavioural benefits for a dividend-based approach, especially for people who are not so financially inclined!

      • Avatar for Dan Montgomery

        Peter Thornhill

        Am I to assume that you are ‘financially’ inclined?

    • Avatar for Dan Montgomery

      Peter Thornhill

      Thank you Nodrog.

  5. Avatar for Dan Montgomery


    Great post

    Spending dividends is seen by many as ‘safe’, the dividends also grow over time in line with inflation or better and even in a really bad year (or years) seldom have huge immediate drops that impact. We frame money into mental accounting as either “capital” or “income,” and “spend the income but don’t dip into the capital” doing the latter in a bull year doesn’t have the same regret as doing the same in a bear year and watching the capital side of the ledger erode

    You also can’t control when a company pays you dividends, however you can choose when to sell or you can be forced to sell ( I needs the cash)

    Maybe try comparing VAS to AFI or ARG rather than VHY?

    According to Switzer they have had a tough time of late though …

    …”Investors in Australia’s biggest Listed Investment Companies (LICs) have witnessed a fairly ordinary last 12 months.

    While on paper the portfolio returns of around 9% look reasonable, this masks the fact that they have under-performed the benchmark S&P/ASX 200 accumulation index by between 2.4% to 3.4% over this period. And if share price performance is considered (growth in share price plus dividends), they have fared even worse as any premium to NTA (net tangible asset value) has been crunched and they have moved to trading at a discount to NTA. The second largest, Argo (ARG), has returned just 1.5% on this measure over the 12 months to 31 March.

    The move to a discount to NTA is not just related to performance. It’s also a reaction to Bill Shorten’s proposed change to franking credits. I have warned on several occasions that LICs trading at a premium are the most vulnerable group of stocks to any change (more vulnerable than bank stocks or hybrids) because the LIC market is purely a retail market and the premiums defy gravity. Institutional and offshore investors don’t buy LICs. All it takes is a few retail investors to move to the sell side and the premium can crunch very quickly.”…

    A good read here also

    • Avatar for Dan Montgomery

      Dan Montgomery

      Thanks Baz. Good to see that article supports my arguments above. I particularly like these quotes:

      But this preference isn’t entirely new; it has long been known many investors have a preference for cash dividends. From the perspective of classical financial theory, this behavior is an anomaly. It’s an anomaly because dividend policy should be irrelevant to stock returns, as Merton Miller and Franco Modigliani famously established in their 1961 paper ‘Dividend Policy, Growth, and the Valuation of Shares.’

      Strategies have been proposed to eliminate sequence of returns risk with high-dividend stocks. This wouldn’t have occurred to me because sequence risk is caused by systematically selling stocks when prices are low. Cash dividends don’t avoid sales at low prices; they are effectively a forced sale that will occur regardless of the stock’s price and with timing decided by the company.

      In the next post or two we’ll be looking at LICs. To be fair, Thornhill advocates for LICs over ETFs.

  6. Avatar for Dan Montgomery


    Excellent article.

    I have a couple of requests for your next article in this series.

    1. A simulation which shows portfolio value fluctuations as you withdraw 4% from VAS vs most popular LIC (sorry I don’t know much about LICs). In most of cases 4% will be covered by dividends in both cases as VAS also has 4%+ dividend yield.

    2. How much tax one has to pay on that 4% assuming franking credits exist and 50% capital gains discount applies and there is no income other than the one from the portfolio. Portfolio starting value must be same let’s say $1million and 40k needs to be withdrawn yearly.

  7. Avatar for Dan Montgomery


    One thing to watch out for with dividends, especially with the big 4 banks is what is called an underwritten DRP as most of the banks have done these at one time or another especially when APRA was making them increase their capital ratios.

    In this case the dividend isn’t coming from excess profits but actually from a capital raising through the release of new shares (in the DRP, to the under-writer).

    In these cases, technically the dividend wasn’t reduced as they did pay a dividend, but in reality they diluted everyone’s holdings to achieve the payout…

    • Avatar for Dan Montgomery

      Dan Montgomery

      Good point Adrian and not something I had considered!

  8. Avatar for Dan Montgomery


    Very interesting article. I look forward to the next part.

    Would love to see the implications of tax, capital gains and franking credits.

    For me I would lean still towards a dividend approach as share values may fall just on market pessimism alone. Where as I like to believe that dividends are more rational and based on a company’s actual performance. It would be interesting to find a way to see if this is true. Perhaps looking at an LICs NTA history versus its share price in a bear market could be a way of quantifying this? Probably not as market sentiment would still affect both..

    Perhaps this is a generalisation but I feel Australian companies with higher dividends may also be more established/reliable companies. Where as investing for growth may be relying on the expectation of a companies growth vs its actual current business. Obviously this would not always be true however.

    • Avatar for Dan Montgomery

      Dan Montgomery

      I think you’re spot on in regards to which companies pay dividends. It’s generally established companies with fewer opportunities for growth. There’s also probably some structural reasons for dividends being (on average) higher in Australia, i.e. franking credits.

  9. Avatar for Dan Montgomery


    Maybe I’m missing something in the Wesfarmers example. You’ve demonstrated that dividends fluctuate over time, but if you actually apply the principles that FIRE is based on to your example, it shows that the dividends in this case would easily cover the income requirements over this period.

    Every year in the example the dividend is greater than 4%, but you’re trying to satisfy an income that exceeds 4% of the total value of the investment at the commencement date i.e. you want a $65,000 income from shares that are worth $752,400?

    If you want to do a single stock simulation, and you stick to the principles of the 4% rule (by either increasing the shares in your example so the $65k income you are trying to achieve in year one represents 4% of the investments held, or reducing the income needed to 4% of the starting investment balance), then this example would show that the dividends for Wesfarmers over this time period exceeded the income required in every year of the example. Investing the excess income each year in additional shares you’d be even better off.

    If you’re investing in the Australian share market, in shares that are fully franked, you will always be better off financially living off dividends than selling shares (factoring in franking credits, CGT and the opportunity cost of selling shares given most also pay a dividend). I’m not saying that dividends will necessarily always cover your income requirements, the reality is that you will probably end up living on a combination of share sales and dividend income, but dividend income should/would be the preference/goal.

    • Avatar for Dan Montgomery


      I agree the WES example may be a little misleading and perhaps assumes that leading up to the GFC you where spending all dividends and not just $65k. Also like Gee says you would be relying on a greater than 4% yield.

      I imagine that if you had been accumulating only WES as your retirement plan you may have done so for maybe 15-20 years. Which means you may have accumulated a lot of shares at the $11-$20 range. This would mean your equivalent yield or cash flow would be much bigger. This I think is what Thornhill tries to get across in his book.

      As a guess is it worst case scenario to assume you only started your strategy just as the GFC hit and previously had been spending dividends willy-nilly beforehand?

      Dividend yield for WES annually is (from
      2004 4.38%
      2005 3.52%
      2006 4.87%
      2007 7.46%
      2008 5.56%
      2009 10.28%
      2010 3.52%
      2011 3.93%
      2012 5.08%
      2013 4.48%

      Which doesn’t look too bad to me considering the individual who accumulated these shares at a cheaper price would be fairing even better!

      Of course none of this means a capital growth strategy couldn’t have done better/same, but it seems like this hypothetical WES investor would be doing pretty good right now 🙂

      • Avatar for Dan Montgomery

        Dan Montgomery

        Why are you applying the 4% rule to dividend income? The 4% rule measures the likelihood of running out of money during retirement if you sell down your shares. This is precisely what you’re not doing. The 4% rule doesn’t tell you anything about the likelihood of dividends covering your retirement income.

        And I would add that looking at dividend yield is a poor measure of performance. This is because the yield is a function of the share price, which you’re saying is irrelevant.

        • Avatar for Dan Montgomery


          I think the 4% rule has everything to do with it i.e. people use the 4% rule as a guide to determine how much they need to save or have in investments in order to retire. I think any sensible person would still apply this rule, and not stop accumulating once you have a portfolio that just meets your income requirements based on current dividends.

          If you think you need $50,000/y to live on, you build a portfolio of $1,250,000 (I’m not advocating this amount, just using it for illustrative purposes). Let’s assume this $1,250,000 is all in the stockmarket. Once you have your portfolio of $1,250,000, if the dividends on the shares you hold are equal to or greater than the $50,000.00 you need to live on, why would you ever want/need to sell any of your investments? (obviously in the real world dividends will fluctuate and there will be years where dividends will exceed the $50k, and years where they are less – maybe the good years can smooth out the bad years, maybe you need to supplement dividends with sales some years).

          I still can’t think of any scenario where selling is better than receiving dividends. If the argument you’re making is that accumulating investments based on the 4% rule is better than accumulating just enough investments to meet your income requirements at current dividend rates (which may be well below the assets you accumulate based on the 4% rule), then it is a no brainer that you should still target holding investments based on the 4%.

          If you’re holding a stock for dividend purposes arbitrage means nothing.

          • Avatar for Dan Montgomery

            Dan Montgomery

            I suggest that you read about the 4% rule and where it comes from. My point is only that you’re taking a rule that is based on draw down simulations and applying it to income simulations. It only works if you’re also willing to sell part of your share portfolio when dividend income is cut.

          • Avatar for Dan Montgomery

            Peter Thornhill

            Dan, are you telling me that CSL, COH and CCP et al are not “growth” companies because they pay dividends?

          • Avatar for Dan Montgomery

            Peter Thornhill

            Well said Gee.

  10. Avatar for Dan Montgomery


    Thanks for interesting article!

    Although the price of a share generally falls in accordance with the dividend paid out, it’s important to note that during a down fall you aren’t selling off the shares. Under the dividend model you are preserving ownership and are able rise again with the market with your full amount of shares. Under the capital sell off model, you are locking in your losses and reducing your ability to recover after the down fall.

    • Avatar for Dan Montgomery

      Dan Montgomery

      Thanks Anthony. I understand what you’re saying! Again, it comes back to that fact that efficient markets mean that there is no categorical difference between selling shares and receiving a dividend.

      • Avatar for Dan Montgomery

        Anthony Bloom

        ‘Efficient’ is the key word. I think during crises the market is anything but efficient. In fact, during most crises it’s completely illogical. As Dave eluded to above, shares prices can fluctuate quite dramatically as a multiple of earnings.

        I think generally the strategy of selling vs receiving an income delivers a similar outcome however as mentioned above I would be much more comfortable relying on dividend income during a major townturn and preserving my capital.

    • Avatar for Dan Montgomery

      Ramon Vasquez

      Exactly ! Well put Anthony . Good luck . Ramon .

    • Avatar for Dan Montgomery


      Well said Anthony! Investing in dividend paying funds/LICs means you can draw down on the dividends while keeping ownership of the original stocks. In high performing years, reinvest the dividends.
      The 4% rule *is* relevant @Dan. I understand that the 4% rule is about the safe withdrawal rate of selling the portfolio and not running to zero. But the point is this. In a capital withdrawal strategy, you’re withdrawing 4% of the capital and living off that, you have 96% of your previous holding remaining which then grows in value over time. With the dividend income strategy, you’re receiving 4% of the value of the capital in the form of dividends, while still keeping all the underlying assets and the value of those goes up with time. You’re correct that in the end it balances out though, and we’re not arguing that LICS provide *superior* returns to ETFs like VAS, but that they’re not worse. Also from a taxation point of view, LICs can be much better during the accumulation phase.

  11. Avatar for Dan Montgomery


    Great article! Wondering when the follow up articles will be posted! Great eye opening insights thats for sure!

  12. Avatar for Dan Montgomery


    Yeah a good point on comparing 4% to dividend yield – should be looking at the overall cash flow developed by years of investing. My bad.

    That being said the WES example in the article just shows that just because you had an 8% dividend return one year it may not continue (but no shit). Same can be said for a huge growth in one year.

    If anyone retires based on the history of one dividend years payments, and thinks $750k of capital invested will cover that $65k forever, well that’s just poor planning 🙂

  13. Avatar for Dan Montgomery


    You’re making the error, in your WES example, in assuming that during a GFC type event, people wouldn’t reign in their spending to match their income, if they could – and generally they can, and do. You’re also doing the very thing that people criticise Thornhill for sometimes – picking your start date to prove your point – conveniently just before the GFC. Also, no-one is going to retire on a single fund stock pick, and if anyone was silly enough to do so, it sure wouldn’t be Wesfarmers. Run your simulation on something like Argo and see how it goes for you. The dodgy “math” (it’s maths here, remember) is in your table. Run a 30 year projection on a boring old LIC – dividends and share price – and see if you still think the same way.

    • Avatar for Dan Montgomery

      Dan Montgomery

      Hi Geoff and thanks for the comment!

      Firstly, I’m not sure that I understand the relevance of your comment on reigning in spending, as that would apply to both a Thornhill approach and the traditional share sales approach. How would that help us compare the two approaches?

      I didn’t pick the GFC start date to prove my point. In fact, it feels like the most neutral point at which to compare the performance of each approach during a bear market. What start date would you suggest that I use? I’m more than happy to add to the article if you have a reasonable suggestion.

      I agree that nobody is going to retire off a single stock. In another comment (and in the article itself!) I said:

      “I agree that looking at WES isn’t necessarily indicative of the entire market. But if you look closely at the RBA research paper I linked, you’ll see that dividends didn’t recover for three years in nominal terms. This means that in real terms, it probably wouldn’t have recovered for 4-5 years!”

      Finally, I also agree that LICs (for the most part) did not cut dividends during the GFC. I noted that in the article too:

      “And yes, I know there are a bunch of people yelling “what about LICs!?”. It’s true that a number of LICs didn’t significantly cut their dividends during the last financial crisis. But there’s a good explanation for that, which I’ll leave for the next post that focuses on LICs.”

      Let me know if I’ve misunderstood anything you’ve said and thanks again for your comment 🙂

  14. Avatar for Dan Montgomery

    Rohan Gupta

    Dan, thanks for the terrific work on the blog!

    Is there an email id I can contact you on? Having a bit of trouble finding one — apologies if it I’m missing something.

    • Avatar for Dan Montgomery

      Dan Montgomery

      Just shot you an email mate!

  15. Avatar for Dan Montgomery


    I’m not deep enough into this stuff to completely understand the technical aspects of this discussion.

    However, to my mind, if your retirement strategy is largely selling down shares rather than living on dividend income (assuming no other investments), then you are selling off your nest egg; if you wanted to pass something on to family or charity, you’ll have used most of it up when it comes to pass it on.

    Can someone tell me why I’m wrong about that?

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