For most investors, a safe and sound retirement is priority number one. The bulk of many people's assets go into accounts dedicated to that purpose. However, living off your investments once you finally retire can be as challenging as saving for a comfortable retirement.
Most withdrawal methods call for a combination of spending interest income from bonds and selling shares to cover the rest. Personal finance's famous four-percent rule thrives on this fact. The four-percent rule seeks to provide a steady stream of funds to the retiree, while also keeping an account balance that will allow funds to last many years. What if there was another way to get four percent or more from your portfolio each year without selling shares and reducing the principal?
One way to enhance your retirement income is to invest in dividend-paying stocks, mutual funds, and exchange traded funds (ETFs). Over time, the cash flow generated by those dividend payments can supplement your Social Security and pension income. Perhaps, it can even provide all the money you need to maintain your preretirement lifestyle. It is possible to live off dividends if you do a little planning.
Key Takeaways
- Retirement income planning can be tricky and uncertain.
- Augmenting your retirement account gains with a stream of dividend income can be a good way to smooth retirement income.
- Identifying the right mix of dividend-paying stocks with dividend growth potential is vital.
- Investors and retirees alike should not forgo growth altogether in favor of yield.
- Small investors can use ETFs to build diversified portfolios of dividend growth and high-dividend-yield stocks.
It's All About Dividend Growth
Stock dividends tend to grow over time, unlike the interest from bonds. That's one of the main reasons why stocks should be a part of every investor's portfolio. Furthermore, dividend growth has historically outpaced inflation. For those investors with a long timeline, this fact can be used to create a portfolio that is strictly for dividend-income living.
A smart strategy for people who are still saving for retirement is to use those dividends to buy more shares of stock in firms. That way, they will receive even more dividends and be able to buy even more shares.
For example, assume you bought 1,000 shares of a stock that traded for $100, for a total investment of $100,000. The stock has a 3% dividend yield, so you received $3 per share over the past year, which is $3,000 in dividends. You then take the dividends and buy more stock, so your total investment is $103,000. Assume the stock price doesn't move much, but the company increases its dividend by 6% a year. In the second year, you will get a dividend yield of 3.18% on $103,000 for a dividend of about $3,275. However, that is a yield on cost of about 3.28%.
This dividend reinvestment strategy continues to increase the yield on cost over time. After ten years, the hypothetical portfolio from the previous paragraph will produce around $7,108 in dividends. After 20 years, you will receive more than $24,289 a year in dividends.
What If You Are Already Retired?
Compounding of dividend income is very advantageous if you have a long time horizon, but what about if you are near retirement? For these investors, dividend growth plus a little higher yield could do the trick.
First, retired investors looking to live off their dividends may want to ratchet up their yield. High-yielding stocks and securities, such as master limited partnerships, REITs, and preferred shares, generally do not generate much in the way of distributions growth. On the other hand, investing in them increases your current portfolio yield. That'll go a long way toward helping to pay today's bills without selling off securities.
Dividends paid in a Roth IRA are not subject to income tax.
Nonetheless, retired investors shouldn't shy away from classic dividend growth stocks like (PG). These stocks will increase dividend income at or above the inflation rate and help power income into the future. By adding these types of firms to a portfolio, investors sacrifice some current yield for a larger payout down the line.
While an investor with a small portfolio may have trouble living off dividends completely, the rising and steady payments still help reduce principal withdrawals.
Dividend ETFs
It can be hard to find the right stocks for dividends. Furthermore, achieving sufficient diversification is even more challenging for small investors.
Fortunately, some ETFs deploy dividend strategies for you. Dividend growth ETFs focus on stocks that are likely to grow their dividends in the future. If you are looking for current income, high-dividend-yield ETFs are a better choice.
The Bottom Line
While most portfolio withdrawal methods involve combining asset sales with interest income from bonds, there is another way to hit that critical four-percent rule. By investing in quality dividend stocks with rising payouts, both young and old investors can benefit from the stocks' compounding, and historically inflation-beating, distribution growth. All it takes is a little planning, and then investors can live off their dividend payment streams.
FAQs
To live off of dividend income alone, you need to receive enough dividend payments each year to cover your expenses. Once you know how much income you need to cover your expenses, you can divide that by the average dividend yield of your portfolio to get a rough estimate of how much you need to invest.
Is it realistic to live off of dividends? ›
Creating a diversified portfolio, understanding the implications of dividend reinvestment plans (DRIPs) and being aware of tax efficiency are vital steps in maximizing dividend income while minimizing risks. The dream of living off dividends is attainable with the right financial planning and investment strategy.
How much dividends to make $1,000 a month? ›
Look for $12,000 Per Year in Dividends
To make $1,000 per month in dividends, it's better to think in annual terms. Companies list their average yield on an annual basis, not based on monthly averages. So you can make much more sense of how much you might earn if you build your numbers around annual goals as well.
How much do you need to live off dividends? ›
For example, if you require an income of 100,000 per year and were looking at a dividend yield of 10%, you would need to invest 1,000,000. To work out much you need, calculate your required income and then the percentage dividend yield you may be able to achieve.
How much dividends does $1 million dollars make? ›
Stocks in the S&P 500 index currently yield about 1.5% on aggregate. That means, if you have $1 million invested in a mutual fund or exchange-traded fund that tracks the index, you could expect annual dividend income of about $15,000.
How much money do you need to make $50000 a year off dividends? ›
And if you've got a large portfolio totaling more than $1.1 million, your dividend income could come in around $50,000 per year. By then, there could be other dividend-focused ETFs to choose from.
Can you live off dividends of $1 million dollars? ›
Once you have $1 million in assets, you can look seriously at living entirely off the returns of a portfolio. After all, the S&P 500 alone averages 10% returns per year. Setting aside taxes and down-year investment portfolio management, a $1 million index fund could provide $100,000 annually.
Who pays highest monthly dividends? ›
The Top 10 list of companies that have paid monthly dividends in 2022 includes ARMOUR Residential REIT, Inc., Orchid Island Capital, Inc., AGNC Investment Corp., Oxford Square Capital Corp., Ellington Residential Mortgage REIT, SLR Investment Corp., PennantPark Floating Rate Capital Ltd., Main Street Capital ...
Do you pay taxes on dividends? ›
Dividends can be classified either as ordinary or qualified. Whereas ordinary dividends are taxable as ordinary income, qualified dividends that meet certain requirements are taxed at lower capital gain rates.
How to make 3k a month in dividends? ›
A well-constructed dividend portfolio could potentially yield anywhere from 2% to 8% per year. This means that to earn $3,000 monthly from dividend stocks, the required initial investment could range from $450,000 to $1.8 million, depending on the yield.
Living off interest involves relying on what's known as passive income. This implies that your assets generate enough returns to cover your monthly income needs without the need for additional work or income sources. The ideal scenario is to use the interest and returns while preserving the core principal.
How much do I need to invest to make $200 a month in dividends? ›
The first high-octane income stock capable of generating $200 in monthly income from a beginning investment of $27,000 that's split in thirds is retail real estate investment trust (REIT) Realty Income (O 1.46%).
When can you start living off dividends? ›
If it means to pay for 'all' expenses, then no for the 'average' person. For the wealthy it is possible. so at $3025/mo you would need * 12 months = $36,300 of yearly dividends to cover your living. so with investment of $1,210,000 and an average of 3% in dividend payments this is possible.
How much money do I need to invest to make $4 000 a month in dividends? ›
But even at 9.5%, we're talking about a middle-class income of $4,000 per month on an investment of just a touch over $500K. Below, I'll reveal how to start building a portfolio that could get you an even bigger income stream than this today.
Do millionaires invest in dividend stocks? ›
The latest round of 13Fs, which features trading activity for the December-ended quarter, detailed a handful of moves made by successful billionaire investors in ultra-high-yield dividend stocks. I'm talking about publicly traded companies whose yield is at least four times higher than the benchmark S&P 500.
Can you become a millionaire from dividends? ›
Can an investor really get rich from dividends? The short answer is “yes”. With a high savings rate, robust investment returns, and a long enough time horizon, this will lead to surprising wealth in the long run. For many investors who are just starting out, this may seem like an unrealistic pipe dream.
How much can you make in dividends with $100 K? ›
What Can You Make With $100K in Dividends?
| Dividend Yield | Annual Dividends from $100K |
|---|
| 1% | $1,000 |
| 2% | $2,000 |
| 3% | $3,000 |
| 4% | $4,000 |
6 more rowsFeb 16, 2024
“One mistake to avoid,” Cabacungan says, “is to buy a company's stock simply because it issues a high dividend.” If the company has leveraged excessive debt to fund the dividend, it could come at the expense of future profitability and hurt growth prospects.
How do people live off dividends without paying taxes? ›
For example, a married couple filing jointly with taxable income of $89,250 or less for the 2023 tax year would pay no capital gains tax on dividends. Strategies such as contributions to retirement accounts and health savings accounts (HSAs) may reduce your income below the zero-capital gains tax threshold.
