A short while ago on My Own Advisor I wrote a controversial post about the intent to live off dividends and distributions from our portfolio. I know some investors don’t agree with my approach and I can see why. Readers have mentioned the following to me:
“The trouble with a “live off the dividends” approach is that I’d have to save too much in order to create my desired retirement income. For example, I’d need to save between $2.5M and $3M in order to generate $90,000 per year in dividend income. Alternatively, I could get the same $90,000 per year by simply withdrawing from a portfolio of $1.45M (assuming 5% annual growth and the portfolio lasts 30 years).”
“Some of the big banks’ income funds have proven to have unsustainable distributions.”
“Your universe starts to shrink if you demand an average dividend rate of 4% or higher from your stocks. I prefer to own everything and withdraw dividends plus retained earnings (in the form of capital gains) as I see fit. The way I see it, I’m living off retained earnings whether I get them in the form of dividends or capital gains. I don’t see why I need to limit myself to dividends in order to preserve capital.”
No doubt this is a polarizing topic and this article might not help the issue – but here goes.
For me, living off your dividends or distributions is something we’re striving for, for these reasons:
- There are simply too many unknowns about the future. Having ample capital for our financial future will give us many options, including the option to retire early and convert to a total return approach if we really want to.
- If we are able to keep our capital intact we don’t need to worry as much about when to sell shares or ETF units, there are less decisions to make, and consequently there will be less transaction costs and portfolio manipulation.
- Saving and investing this way is my form of forced savings – there is motivation.
I recently caught up with a few dividend investors to ask them some questions about their financial freedom journey, including any plans to “live off dividends and distributions”. As part of this series, here is what Dividend Growth Investor said.
I have been focusing my attention particularly on dividend paying stocks since 2007. I live in the Midwest in the US. My site is Dividend Growth Investor.
I am mostly a buyer of high quality dividend stocks, with solid competitive advantages. My holding period is forever, as long as the dividend is at least maintained. I tend to concentrate my efforts on stocks which grow earnings and dividends, which provides outstanding total returns over time. I only focus my attention to stocks with sustainable dividend payments. I am also a firm believer in diversification across sectors and geographic locations. I hope that my blog will serve as an inspiration for my readers and that it would change their financial lives for the better.
What is your investing goal? Do you really intend to live off dividends or distributions?
My goal is to generate a sufficient stream of dividend income, which grows above the rate of inflation over time. I will achieve that goal by investing in dividend growth stocks, such as the ones found on the list of dividend champions. I will likely achieve the goal of earning more dividends than expenses around late 2018. I do not expect to have to “spend” principle.
Why does this approach work for you?
I find it easier to model dividend income than total returns. Dividends are a more stable component of total returns than capital gains. This makes it easier to track how I am doing relative to my goal. The amount and timing of capital gains is unpredictable, which makes it difficult to make projections using a total return centric only approach. Since dividends are more stable, it is easier to just spend them, and leave the capital intact (so that money can compound and maintain purchasing power over time).
Will you eventually “eat” your capital and if so, how?
I do not expect to sell assets in order to pay for my expenses. I plan to live off dividends in retirement.
In old age, I will start donating assets to relatives and charitable causes.
I believe that index investors who withdraw more than 4% from their portfolios will increase their risk of running out of money in a traditional 30 year retirement span. During the time of the 4% rule studies, the average yields on stocks and bonds was around 4% or more. So in situations like today, when average yields are around 3%, a safer withdrawal rate would be around 3%. Astute readers would notice that the success of the 4% rule has been based on the yields at the time the study was done. Given the low yields today, an investor who reduces their withdrawal rate to 3% would do well.
How close are you to realizing your retirement goal? What are your assumptions about your savings rate, your portfolio value and your rates of return needed?
I expect that my annual dividend income will exceed annual expenses around late 2018. My assumptions are that I will invest money in companies yielding 3% – 4% on average that grow dividends by approximately 6% average per year. At a 3% yield in 2018, this would translate into a portfolio value that could support me over 400 months or 33 years. At a 3.50% yield, the portfolio value could support me for 342 months’ worth of monthly expenses. At this stage of the game, most of the gain will be driven by investment performance. However, I try to save at least 50% of my income, and then try to find ways to increase that income.
Any last words you wish to share about your approach?
The most important thing that an investor can do is develop a strategy that they can stick to through thick and thin. This means dividend investing or indexing or another strategy. Otherwise, the investor will risk selling at the most inopportune times, effectively undoing years of compounding. Continuous education is also very important. Having conservative expectations, and building some margin of safety in your approach is important as well. It is important to think realistically what could go wrong with your investments and how to protect yourself from that, rather than merely rely on historical investing data.
Thanks to Dividend Growth Investor for sharing some insight into his strategy to live off dividends – the first investor in this series. I’ve been following his blog for years and he’s getting closer to his goal – I hope he hits it in 2018. The goal of living off equity dividends (or distributions) can be a prudent strategy but it’s not for everyone and dividend investing also has risks. Only you can decide what is right for you. I encourage you to consult a financial professional in the form of a fee-only advisor if you need help with your financial plan.
Share your thoughts on this article – I’m always happy to hear from you!