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How much should I set aside to live off my dividend income?

by Marcus 4 months ago in personal finance · updated about a month ago
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Dividend investing made easy

Photo by Online Entrepreneurs

For most people, wanting a comfortable life be it retiring early or having financial freedom it involves having a pool of funds which is a number one priority. However, figuring out how much you need to be invested so that you can finally retire can be as challenging as saving for a comfortable retirement.

So how exactly do you live off your dividend income?

Here are some of the things you may need to consider:

  1. Figure out how much you are earning now.
  2. Figure out how much dividend income you want annually upon retiring.
  3. Figure at what age do you want to retire. Early or retirement age?
  4. Calculate how much you need to be invested in dividend-paying stocks so that the annual dividend yield provides you with your desired annual income.
  5. Find out which type of dividend-paying stocks best suits your requirements, (eg div yields, type of stocks, volatility, industry etc).
  6. Lastly, find out how much you need to set aside monthly or annual to achieve this sum of money.

So the goal here with this strategy is to simply invest your money and have a large pool of money invested, and then you would essentially be living off of the dividend income or the growth of that money without ever touching the principal.

And as I’m sure you guys can imagine, if you’re not touching the principal or your initial investment, then your money could foreseeably last forever.

“If you don’t know where you are going, you will go nowhere.”- Henry Kissinger

Things to consider

Now, the sooner you’re able to retire is all based on how much money you’re able to save up and how little money you are spending each and every month. And there’s actually a whole movement of people that are following this exact strategy, and it’s something out there called F.I.R.E. Fire which stands for Financial Independence Retire Early.

Let’s say you’re earning a salary of $60,000 per year from your job, and ideally, you don’t have any school loans, student loans, medical bills, or anything like that. Your take-home pay is $45,000 as an average.

Firstly, would then need to consider how much you need to be invested in dividend-paying shares to generate this amount of $45,000.

According to Barrons, in June 2021 the average div yield in the S&P 500 is at 1.3% yield. The average dividend yield in the last 5 years is around 1.7% (2% rounded). The average dividend yield in the financial and basic materials industry is 4%. Some stocks even have dividend yields up to 6%-9%.

Below is an outline that may give you an idea of the average dividend yield compared to the different industries.

Source: Dividend.com

How Much Money do you need to Invest to live off dividends?

  • Annual Income You Want/ Dividend Yield= Amount You Need Invest

Using the example above

Eg, if you want an annual dividend income of $45,000 and your average dividend yield is 4%, you would need $1,125,000 invested. Using the S&P 500 at the average dividend yield of 2%, you would need to have invested $2,250,000.

Another eg, if you want an annual dividend income of $70,000 and your average dividend yield is 4%, you would need $1,750,000 invested. Using the S&P 500 at the average dividend yield of 2%, you would need to have invested $3,500,000.

What is dividend yield?

If you are wondering what is a dividend yield, it is a percentage that shows how much a company pays out in dividends each year relative to its stock price.

Below is the dividend yield formula:

Example 1- using a 4% yield

So the main question is how do you reach your goal of $1,125,000 using the average 4% yield?

If you had an initial investment of $5,000 and then continued to contribute $1,500 every single month for 25 years with a dividend return of 4% and an average growth rate of the stock and the average growth rate for the dividend at 8% you will be able to achieve your goal.

In 25 years you would be worth $1.4 million. You would have an average annual income of $56,000 (4% x $1.4m), all completely passive dividend payments, and you could finally become financially free.

Example 2- using a 2% yield

How do you reach your goal of $2,250,000 using the average 2% yield?

If you contribute $2,366 every single month for 25 years with a dividend return of 2% and an average growth rate of the stock of 8% you will be able to hit your goal.

In 25 years you would be worth $2.2 million. You would have an average annual income of $44,000 (2% x 2.2), all completely passive dividend payments. You could finally become financially free.

You can see how dividend yield affects the annual income you receive so you want to be conscious of the dividend-paying stocks that you are invested in.

You will also be considering the industry that you're investing in and the industries performance which affects the dividend yield rate. You will consider your desired annual income to estimate how much you need to set aside monthly or annually to achieve your desired annual income and how much time you have available to invest.

Below summarises, some key areas you will consider:

  1. Dividend yield rate.
  2. The number of years you have available to invest.
  3. The contribution amount to invest.

Desired annual income

Let's break the dividend amount that you want to receive annually into smaller chunks so that the amount you can start setting aside with your current income seems more manageable.

How do I make $500 a month in dividends?

To make $500 a month ($6,000 per year) from dividends you’ll need to make at least $1,500 per quarter of the year. At a 4% dividend yield that equates to $150,000 invested in order to receive $500 per month dividend payments.

How much money do I need to invest to make $3,000 a month?

To make $3,000 a month ($36,000 per year) you’ll have to invest roughly $900,000 into dividend-paying stocks. This is using the average dividend yield of 4%.

How much does it cost to earn $1,000 in dividends?

Below will give you a better idea of how much you need to set aside to earn $1,000 in dividends.

Photo by Carbon Finance

How to get there?

For this to happen you need to:

  1. Consistently invest a fixed sum of money into dividend-paying stocks.
  2. Reinvest the dividends received to buy more stocks.

I really believe that anyone can achieve financial freedom, they just need the willingness, the discipline and the focus to get there. You can see with the examples above, you can achieve financial freedom relatively easy without having to start up a business, do real estate, create a company, or do anything relatively drastic from your day to day life.

By being diligent and consistent you are able to achieve your desired annual income.

Working backways to find out how much you want annually to be able for you to achieve this financial freedom makes it so much easier since you have an end in mind you are better focused to achieve this goal. This is compounded by the awareness and knowledge of how much to budget and set aside each month.

“Begin with the end in mind. “ — Stephen Covey

Conclusion

Lastly, if you want wealth, be wealth. Talk it, think it, prepare yourself to have it. You would be amazed at how much you can achieve.

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personal finance

About the author

Marcus

Entrepreneur, Youtuber, Fencer

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