Today we are answering this question: Can You Live Off Of Dividends? The short answer is, yes! You can live off of dividends. the tricky part is determining where to invest and how much money you’ll need.
To determine how much you need, simply divide your annual expenses by your expected annual dividend yield, less any taxes.
Seems easy, right? Maybe not… let’s break this down!
Whether it’s for an early retirement or just regular retirement in your 60’s/70’s, retiring and living off of dividends sounds like a nice prospect. You’re quite literally putting corporate America to work and living off of the fruits of their labors. All you have to do is collect the dividends; no selling of assets required!
Step 1 – Determine How Much Money You Need
This is not something I can just tell you, this is your job! But the first step here is figuring out how much money you’ll need per year. Prepare a budget and forecast out your annual expenses, and don’t forgive to leave a buffer for safety.
In the event of a market downturn, you’ll want this buffer as your dividends may be cut. This has happened in the past and you don’t want to be caught wrong footed.
Also, make sure you’re capturing any other income you may be receiving. Whether it’s Social Security, a pension, or rental properties, make sure you reduce the amount of money you need by that value. Otherwise you might be double counting income and could be retiring sooner!
Lastly, don’t forget taxes! Dividends have different tax rates depending on your income as long as they are qualified. Your taxes could even be zero! This is incredibly situational dependent and you should consult your CPA on this topic.
Step 2 – Forecast Your Dividend Yield Required
You should now know how much you need annually in dividends. From here, you need to figure out how much you need to invest!
If you already have a large lump sum ready to invest, what you can do is take your required annual dividends from above and divide from your lump sum. This will give you the approximate dividend yield you should be seeking.
As an example, let’s say I need $40,000 a year in dividends from Step 1. I have $1m saved up and looking for an investment home. If I take $40,000 / $1,000,000, I get a 4% yield. That will be my target fund yield… which brings us to the next step.
Step 3 – Determine Your Investments
Since you want to live off of dividends, your best bets are likely dividend paying ETFs. Luckily, I’ve prepared an article here showing several ETFs that can provide different levels of passive income.
But as a quick recap, here’s what you can choose between in terms of ETF types.
Common Stock Based ETFs
Common stock based ETFs like dividend index funds generally have a mixture of dividend income and price appreciation. These are perfect for investors looking to live off of their dividends, but also hope to see their portfolio value rise over time.
The other benefit of these funds is that their dividends are generally qualified dividends after the required holding period.
The downside of these funds are that they tend to have lower dividend yields. Depending on the market state at the time you’re reading this, you can generally find funds paying out a 3-5% dividend yield annually.
These funds also carry the same risk as general equities and carry large downside risk in the event of a recession. During these periods, many companies cut or suspend their dividends to investors to save cash. So you need to be prepared for this!
Some examples:
- SCHD – Dividend Yield (TTM): 3.51%
- FDVV – Dividend Yield (TTM): 3.77%
- SPYD – Dividend Yield (TTM): 4.80%
Real Estate Investment Trust (REIT) ETFs
ETFs investing in REITs are great because many provide a higher yield compared to common stock ETFs. REITs must distribute the majority of their earnings each year to their shareholders, meaning that potentially more money comes into your pockets!
Also, because REITs own real estate, you have the possibility of capital appreciation due to their underlying holdings. REITs also give a headache-free exposure into the real estate market.
On the downside, REITs can be quite cyclical (see the 2008 financial crisis) and carry significant risk. Also, the dividends from REITs and their ETFs cannot be considered qualified dividends. This means your tax burden will be higher.
Some examples:
- VNQ – Dividend Yield (TTM): 4.13%
- FREL – Dividend Yield (TTM): 3.73%
- SCHH – Dividend Yield (TTM): 3.24%
Bond Fund ETFs
Bond fund ETFs are great because there are several different types, making fine-tuning your portfolio much more simple. There are two categories I’ll go through today, aggregate bond funds and high-yield bond funds.
Aggregate Bond Funds
Aggregate bond funds are less risky bond funds because they invest in a broad range of bonds. These could be a mix of treasuries or high rates corporate bonds, and have various terms (long or short).
These bond funds are generally less risky than high-yield (which we’ll get to), but also carry lower yields. These are great for investors looking for some downside protection in exchange for lower rates of return. These funds also generally pay dividends monthly which is great for cash flow!
On the downside, these generally do not bring capital appreciation. This is because these ETFs pay out the majority of their earnings. These funds are also highly sensitive to interest rates.
You can fine tune your investments in this area by picking more risky bonds like corporate bonds, longer term bonds, etc. for more yield. Or conversely, you can pick safer ETFs like long-term treasuries if you’re worried about downside risk.
Some examples:
- VCLT – Dividend Yield (TTM): 4.68%
- BLV – Dividend Yield (TTM): 4.06%
- BND – Dividend Yield (TTM): 3.08%
High Yield Bond Funds
High yield bond funds are the riskier option for dividend income. These funds invest in “junk bonds” or, in nicer words, bonds issued by companies that are not investment grade. These bonds are riskier but also carry a much higher yield.
These funds are perfect for longer-term investors who are less concerned with downside risk. In return, you can be rewarded with much higher immediate income and a higher long-term rate of return.
The downside is obvious. These funds can take a beating in a market downturn. As companies go bankrupt, generally the most risky do first. So the ETF may be collecting debt for pennies on the dollar, which can erode your investment.
But as we say in investing – the more risk, the more potential reward!
Some examples:
- USHY – Dividend Yield (TTM): 6.62%
- HYG – Dividend Yield (TTM): 5.73%
- JNK – Dividend Yield (TTM): 6.41%
Bottom Line
You should now know if you you can live off of dividends? The answer is a resounding yes, it is possible! By following the steps above, you know it’s a simple mathematical problem. Simply determine your annual spending needs pre-tax, determine your yield required, and then pick the right investment option for you.
From common stock ETFs, REIT ETFs, or Bond Fund ETFs, there are many different ways to get there. Happy hunting!
DISCLAIMER – THIS ARTICLE IS NOT FINANCIAL ADVICE. THIS ARTICLE DOES NOT CONSTITUTE A BUY, SELL, OR HOLD RECOMMENDATION ON ANY SECURITY MENTIONED HERE. THIS ARTICLE CONSTITUTES MY OPINION AND NOT A STATEMENT OF FACT. ALL INFORMATION REGARDING THE FINANCIAL SECURITIES MENTIONED IS ACCURATE AS OF JANUARY 19, 2024. DO YOUR OWN RESEARCH.