Dividend investing is considered the ultimate passive investment, you’re sunning yourself on a beach and suddenly it’s that time of the year again. Your dividend income for the quarter has hit your account and you order a few more martinis whilst realising you didn’t lift a finger to make all that money. In all seriousness though, it’s a great feeling when you make money from dividends but how much money invested do we need to actually live off our dividends? We discuss this below. 

What are Dividends 

We have discussed this in more detail before but dividends are essentially a public companies way of sharing profits with its shareholders (those who own shares in the business). It’s an added bonus to making money through capital appreciation and companies that pay dividends are usually more well established blue chip companies who want to retain shareholders who might go looking for better returns elsewhere in things like growth stocks. 

Capital appreciation is the increase in value of an investment, if you have a stock that costs $100 and it rises to $105 then the investment has seen a capital appreciation of 5%.

Things to Consider When Trying to Live off Dividends

There are a few factors to consider when you’re trying to work out if you can live off your dividend income. Firstly, how much money are you investing each month? Dividend investing isn’t much use unless you’re investing a substantial sum of money each year. Investing $1000 per month is exponentially better than investing $500 per month for example and the more money invested early on, the more time compound interest has to take hold. 

If you’re investing your money in something like the S&P 500 which produces a dividend yield of around 2% (it has fluctuated a bit due to the recent pandemic) then you’re going to get a smaller dividend return initially over picking stocks that have a yield of 4%. 

The dividend yield is a percentage of a single share that the business is willing to pay you for holding that share. Yields vary from company to company but typically yields range from 0-4% (they can go higher but it’s not always a good thing to invest in a company that pays so much of its earnings out to shareholders in the long run). To give you an example Apples share price is approximately $143 at the time of writing, Apples dividend yield is 0.6% which would mean for every Apple share you hold you would receive a dividend payment of $0.85.

‘Initially’ was the most important word when we discussed dividend yields there, the S&P 500 has seen a long term return of around 9-10% and closer to 13% in the last 10 years it you reinvested your dividends. This means there has been an average annual capital appreciation of 7-8% in the market index over the long run and on top of that a 2% dividend yield. If we take a stock that produces a 4% yield and capital appreciation of 3% per year then over time the dividends paid out by investing in the S&P 500 will be higher than the stock with a higher yield. Why is that you ask? 

The current price of Vanguards S&P 500 fund is $83.34 but for the sake of this example let’s assume it’s $100. If that $100 share rises to $300, then your 2% yield effectively rises to 6% of your initial investment (because the stock price has risen by 200%). The point we’re making here is high yield isn’t always best. As previously mentioned, stocks with a high dividend yield are often blue chip companies that don’t have that much growth over time so by investing in funds that increase in value per share can actually pay you more in dividends over time. Think Apple, Mastercard and Visa here, maybe not the highest dividend yields but they’ve seen tremendous growth in the last decade so those who got in early would now be reaping the rewards in dividends. 

We briefly touched on reinvesting your dividends but this is an important point to help compound growth over time. If you’re planning on living off your dividends in the future then you’re more than likely going to have to reinvest any dividend payments you gain along the way (unless you’re Warren Buffett who makes over $4 billion in dividends, yep that wasn’t a typo). Over the long run this will take years off the time it takes to live off dividends, possibly decades.

Probably the most important question you have to ask yourself when discussing whether you can live off your dividends is how much are you spending. If your expenses are $40,000 per year and your portfolio has a yield of 2% then you would need $2 million to sustain your way of life, not exactly a trivial sum of money. If you can cut your expenses in half then you can cut the amount you need to save in half as well.

Bottom line

It typically requires a substantial amount of money to live off dividends but by investing long term, compound interest can do its thing and help capital appreciation/ reinvested dividends to provide a good dividend return. It’s often easier to downsize your expenses than upsize your investment portfolio so if you want to live off dividends sooner why not consider cutting as many expenses as you can and living frugally? 

If you want to learn more about dividends, you can find Josh Peter’s book ‘The Ultimate Dividend Playbook’ on Amazon here.

The views expressed in this post are the authors and should not be construed as financial advice

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David is an Engineer and Finance Writer educated to masters degree level with sound knowledge in investing, the stock market and personal finance. We hope the information provided on this site can help you achieve your financial goals.

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