Dividends are regular payments that companies make to shareholders. Many investors choose to reinvest their dividends, but you can receive them in cash. But how much do you need to invest to live off dividends, and could you retire on dividend income?
Let’s find out.
How Do You Live Off Dividends?
Living off the passive income from your investments and becoming financially independent is a captivating idea, especially if you can do it earlier than you expected.
Fortunately, there are many ways to create an investment portfolio that can support you indefinitely. One popular option is to invest enough money in assets that pay enough dividends to cover your annual expenses.
To figure out the amount of money you’d need to invest to live off dividends like this, you’ll need to define two variables: the amount you plan to spend per year and the dividend yield of your intended portfolio.
Once you have them, divide the former by the latter to get your portfolio value.
👉 For example:
Say you plan to spend $40,000 a year to support yourself and your family in the future. If you believe you could achieve a portfolio with a dividend yield of 3%, divide $40,000 by 3% to find a minimum portfolio value of $1,333,333.
$40,000 / 0.03 = $1,333,333
The best way to start building a spending plan for the future is to assess your current expenses and adjust them as necessary. I always suggest plugging your debit or credit card into a digital budgeting tool so you can automatically track all your expenses in one convenient location.
You could write everything down using pen and paper the old-fashioned way, but why would you? It’s too easy to forget cash transactions, make typos, or give up on the practice altogether that way.
📘 Learn More: If you’ve been tracking your spending for a while and want to start building a budget, check out our helpful introduction to the subject: Budgeting 101: How to Budget Your Money.
What’s a Realistic Dividend Yield?
Once you know how much you plan to spend each year, you’ll need to figure out what kind of dividend yield you can reasonably achieve. While your mileage will vary, you can generally expect a dividend yield roughly between 1% and 6%.
Your investment portfolio’s total dividend yield will depend on its composition. Here are some examples of average historical dividend yields on some popular assets for reference:
- Vanguard S&P 500 Index Fund ETF: 1.85% long-term average1
- Ford Stock: 4.88% average over the last five years2
- Schwab US Real Estate Investment Trust (REIT) ETF: 2.67% over the last five years3
While you can’t know for sure what dividends an asset will pay out in the future, you can get a good idea by reviewing its historical yields. You should be able to find them featured prominently on the asset’s page at your brokerage or using independent databases online.
How to Evaluate Dividend Sustainability
When you’re building a portfolio of dividend-paying assets, it’s tempting to pick the ones with the highest yields, but that’s a risky strategy. There’s a lot more to consider when evaluating the value of a stock than its dividend. In fact, those with the highest yields can be the riskiest.
👉 To calculate the dividend yield of a stock, you divide its annual dividend by the price of one share. For example, if a stock pays a $5 dividend yearly and costs $100, it has a 5% dividend yield.
That means there’s an inverse relationship between yield and stock price. If one goes down, the other goes up. Someone who picks stocks for their increasing yields could accidentally acquire assets that are dropping in price, which is a quick way to lose money.
Because of this, you should always assess the sustainability of an asset’s yield before adding it to your portfolio.
👉 For example, you could examine its dividend payout ratio, which equals its dividend divided by its net income. A company that nets $1,000,000 for the year and pays out $100,000 to its investors has a 10% payout ratio.
If it’s over 100% and has been for a few years, the company is paying out more than it makes, which isn’t possible forever. Conversely, a ratio that has been steadily increasing for a decade could be a sign that the business is maturing healthily.
If you’re going to live off dividends from your portfolio, make sure you do this kind of due diligence before you invest in anything. You want those dividends to last.
Dividend Tax Considerations
Don’t forget to factor taxes into your dividend calculations. If you’re receiving your dividends from equities in a traditional 401(k), IRA, or taxable brokerage account, they will be taxable income.
However, they’ll be subject to different tax rates. With a traditional retirement account, you won’t pay taxes on dividends while you reinvest them. Once you start taking them as distributions, though, they’ll be taxable at ordinary income rates.
If you take your dividends from a taxable brokerage account, they will receive one of two tax treatments, depending on whether they are:
- Qualified: These are taxable at the discounted long-term capital gain rates of 0%, 15%, or 20%.
- Ordinary: These are taxable at ordinary income rates, which range from 10% to 37%.
If your dividends come from after-tax accounts like Roth 401(k)s or IRAs, you can avoid the issue altogether. You won’t pay taxes on reinvested dividends or those you take as distributions.
Make sure you know the significance of these two types of taxation, as they can skew your numbers significantly.
👉 For example, $30,000 in qualified dividends taxable at 15% is $25,500. The same amount in ordinary dividends taxable at 24% is $22,800. That’s $2,700 less each year and $225 less per month.
It’s always a good idea to get personalized tax advice regarding the implications of any investment strategy. Consider discussing your approach with a tax expert like a Certified Public Accountant or Enrolled Agent, or read what the IRS has to say about dividends.
📘Learn More: If you need to brush up on the different types of personal income taxes, take a look at our overview of the subject: Taxation 101: How Do Taxes Work For Individuals?
How Much Do You Need to Invest to Live Off Dividends?
How much you need to invest to live off dividends is a function of your annual expenses and the dividend yield of your portfolio. Let’s look at some realistic examples of portfolios you could create to live off dividends in various scenarios.
1. Single Person in California With a High Risk Tolerance
Jack is a single person who spends $48,000 to support himself each year in an area of California with a relatively high cost of living. He has a high risk tolerance and is comfortable putting together a portfolio in retirement that’s more heavily weighted toward equities than bonds and contains plenty of REITs with high dividend yields.
He expects his retirement portfolio to pay a dividend yield of 6% per year. $48,000 divided by a 6% yield means he’ll need to invest about $800,000 to live off dividends.
$48,000 / 0.06 = $800,000
⚠️ These numbers are, of course, estimates. You can never be entirely sure how much you’ll spend or exactly what dividend yield you’ll receive in the future. Both amounts can and will fluctuate, so make sure you build in a buffer according to your risk tolerance.
2. Single Person in Florida with a Medium Risk Tolerance
Jill is a single person in Florida and spends $30,000 a year to support herself in a city with an average cost of living. She also has a pretty average risk tolerance and is comfortable with a portfolio that has a weighted average dividend yield of 4%.
$30,000 in annual spending divided by a 4% yield means she’ll need to invest about $750,000 to live off dividends.
$30,000 / 0.04 = $750,000
3. Married Couple in Texas with a Low Risk Tolerance
John and Jane are a married couple living in Texas. After their children move out, they expect it will cost them about $40,000 to support themselves. They’re relatively risk-averse and want to focus more on wealth preservation than anything. As a result, they create a portfolio that will have a dividend yield of around 2%.
$40,000 in annual spending divided by a 2% dividend yield means they’ll need to invest $2,000,000 to live off dividends.
$40,000 / 0.02 = $2,000,000
📘 Learn More: While inflation will probably increase your annual expenses over time, dividend payments tend to keep pace with it. To learn more about how inflation would affect your retirement, read this comprehensive guide to the concept: How Inflation Works: An Illustrated Guide for the Rest of Us.
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Can You Live Off Dividends?
While you can live off the dividends from your investments, it might not be the optimal retirement strategy. You’re generally better off optimizing your portfolio’s total return than you are chasing a high dividend yield just for the sake of dividends.
While there’s something instinctively satisfying about living solely off dividends, it’s usually not necessary to distinguish between living off dividends versus a portfolio of equities in general.
In truth, there’s no practical difference between distributing money from your portfolio through dividends or through selling assets.
🤔 Think of it this way: Your dividend yield is just a portion of the total return on your portfolio. If you have a 10% return, it doesn’t matter whether it breaks down to 5% value growth and 5% dividend yield or 9% value growth and 1% dividend yield.
In other words, if an asset pays you a dividend of $500 and you reinvest it, that’s the same as if the shares increased such that your position’s value went up by $500.
The difference, of course, is that a dividend is relatively predictable, while appreciation is not.
The only difference to an investor would come from a variance in tax rates when taking distributions from a taxable brokerage account. In most cases, though, that will work out in favor of selling assets over taking dividends anyway.
If you manually sell portions of your retirement portfolio, you can use the first-in, first-out basis, which means the first asset you sell is the first one you acquired. These should always be subject to long-term capital gains taxes if you’ve been investing for years.
Meanwhile, ordinary dividends are subject to the less favorable ordinary income tax rates.
You’ll also have more control over the timing of your earnings if you sell portions of your portfolio manually. Shareholders don’t get to decide when they receive their dividends or how much they’ll be.
📘 If you prefer a buy and hold strategy but you still want market-beating growth, there’s a variant of dividend investing that you should consider – Dividend growth investing
Frequently Asked Questions
Dividends are payments made to shareholders, so only equities pay dividends. That means you can invest in assets like stocks, stock market index funds, and real estate investment trusts (REITs) to receive index funds.
You can expect an investment portfolio to pay out dividends roughly between 1% to 6% of its value each year. At those dividend yields, you’d need a portfolio value between $100,000 and $600,000 to make $500 per month in dividends.
If you’re open to income sources other than dividends, there are many ways to make $3,000 a month passively. For example, you might pay $15,000 apiece for four rental houses that net $750 of profit every month. Alternatively, you might invest $900,000 in passive index funds and use a safe withdrawal rate of 4% to take $750 out each month.
📘 Learn more: $3,000 per month in passive income is a common goal among investors. Check out our guide below for a deeper analysis of various ways to reach it: How Much Money Do I Need to Invest to Make $3,000 a Month?