How much do you need invested to live off dividends?
Is it even possible to live off your dividends?
I’ve asked myself this question too many times since the day I learned about dividends and the F.I.R.E movement.
The F.I.R.E movement stands for Financially Independent, Retire Early. From the day I stumbled upon this acronym I’ve been scratching my head. How much do I really need to have invested to be able to quit my job and become a full-time couch-potato?
The answer you want is dependent on a lot of variables: the country you live in, inflation, what you are investing in, etc.
The dividend itself is dependent on the company’s profit and management.
You should invest in index funds that focus on high dividend yield companies.
Different Yields
We have to take into account the difference between yields. Not only do they differ from one company to another, but they change almost every day. However, good luck taking into account the change that occurs every day, you will go insane before figuring out a formula that works.
The difference in yields is important because the lower the yield, the higher the amount you will have to invest.
That doesn’t mean you have to invest in only high yield companies. Matter of fact, that can be a true bait, sometimes. Some companies inflate their yield so much and their dividend becomes so unsustainable that they are forced to cut it to $0 to keep the company afloat.
Payout ratios should never be 100% or above. I, personally tend to look for payout ratios below 70%.
Dividend Growth Investing
Investing in companies whose dividend has the potential to grow and whose management tends to increase the dividend. It doesn’t have to be annually or even a substantial increase. A simple increase is enough for the strategy to work. That’s what a dividend growth investing strategy looks like.
Let me give you a hypothetical.
Let say this one index fund is selling for $100. The dividend right now is $2.50 annually which gives it a 2.5% dividend yield. Not bad, but not great too.
If we buy the index fund today, we are getting a 2.5% dividend for the money we just invested, but if let the same stock be there quiet in our portfolio and let the fund’s companies increase their dividends, the $100 we spent buying the stock is no longer making us $2.5/year but is now making us, let’s say, $5/year.
No, the increases are not like the example I just gave. you can expect an increase of 3% each year. For example, last year, Coca-Cola increased its dividend for 2.5%.
That’s an easy formula to make in an excel spreadsheet, look.
As you can see, with a $300/month investment, over 20 years with no market downturns and with consistent dividend growth of 2.53% and a dividend yield of 3.63% you would be making $5,405/year.
The actual formula
First, you have to know how much money you really need per year. The money you need to survive. Your monthly budget X 12.
I’m just going to assume you aren’t balling out of your mind and can live with $2,000/month. I know that in the US or in a higher income country that might not seem a lot, but I’m in Portugal and 2,000€ here get you a pretty comfortable living.
$2,000/month amount to $24,000/year.
If that is what you can live with then this is the formula.
$24,000/0.04 = what you need invested
You might be thinking “how does that even work?” and I, as the gentleman I am, will explain.
24,000/0.04 =600,000 Right? Ok stay with me.
The SP500, which includes the top500 companies in the US according to market capitalization grows at a 7.5% rate each year on average.
This means you can, in theory, sell off 4% of your investments and still have those 3.5% growing and then reinvest the dividends. That makes it that you will never run out of money and will even outrun inflation so you will never lose purchasing power.
“Wait… Reinvest the dividends? I thought this was an article about living off my dividends”
Ok calm down, I’m getting there.
What I just told you is known as the 4% rule. Again, you sell 4% of your investments, reinvest the dividends and keep the 3.5% of the growth that’s theoretically left. To be fair, the rule is actually to multiple those $24,000 by 24 and then do the rest, but I find it way simpler and more effective to just divide by 0.04.
What if you don’t want to sell any of your investments? What if you just want to live off of your dividends?
Then, this is the formula: $24,000 / (your portfolio’s average dividend yield)
More complicated right? Let me simplify it.
You take all your investment’s dividend yields, add them up and divide the result by the number of yields you took into consideration. This will give you an average.
To make this simple, I’m going to use the dividend yield of the Vanguard High Dividend Yield Index Fund Admiral Shares (VHYAX) which is 3.72%
$24,000 / 0.0372 =$645,161
What does this mean? Well, this means that with a dividend yield of 3.72%, you would have to invest $645,161 to get paid $24,000 per year in dividends.
Full disclosure, this is a dangerous tactic to live by. In my arguments, I did not take into account any volatility in the market, just a 7.5% yearly growth. I didn’t take into account inflation which is a big concern because $100 in 20 years are only worth $68 in today’s money.
I went into much more detail about inflation here.
I didn’t take into account any scandals or even pandemics that might occur.
Please, be careful and do your research.
This article is for informational purposes only. It should not be considered Financial or Legal Advice. Not all information will be accurate. Consult a financial professional before making any major financial decisions.
