How to Retire on Dividends

Your portfolio can fund your expenses indefinitely if you live off dividends. As long as dividends are coming in, you won't have to work or worry about your portfolio's worth.

Your dividend stocks and funds deposit recurring dividend payments into your brokerage account throughout the year.

These cash payments can be used for housing, food, healthcare, travel, and other living needs. Without selling any stock.

Dividend investment separates your money from your time, a vital prerequisite for retirement. Can dividends support you?

We've seen firsthand how thousands of investors have implemented this income approach to become financially free.

Let's look about dividend retirement.

How to live off these Dividends

The Wall Street Journal gave a concrete illustration of how dividends might contribute to a financially secure retirement.

The article assumed you will retire with $1 million and require $40,000 year, adjusted for inflation. It was also assumed that long-term inflation runs at 2%, that Treasury yields equal inflation, and that stock dividends grow at a pace of 3.5% annually.

It then specifies that you invest $400,000 in Treasury bonds and $600,000 in equities yielding 3%, resulting in annual dividend income of $18,000.

After spending every dividend dollar, you sell a portion of your bond portfolio to reach your inflation-adjusted yearly income goal of $40,000. Approximately 21 years from now, your bond portfolio would be completely exhausted.

Nevertheless, even after adjusting for inflation, your annual dividend income may have increased by a third to $24,000 over that time period. Moreover, you would continue to own all of your stocks.

If your dividend income grew by around 33% after correcting for inflation, it is reasonable to assume that the value of your assets increased by a similar amount, maybe reaching close to $800,000 over time, due to their increasing cash flow.

Assuming you retired no earlier than age 60, you would be in your 80s with a substantial amount of assets remaining for the remainder of your retirement.

While your initial mix of stocks and bonds will vary based on a number of personal characteristics, it is quite possible to construct a portfolio of high-quality dividend companies that collectively yield at least 3% and grow their dividends by at least 3.5% annually.

However, the number of dividend-paying stocks required to make ends meet depends on a number of variables.

What Is the Minimum Amount of Money You Need to Retire on Dividends?

To establish a reasonable range for how much you need to invest to live off dividends, multiply the annual dividend income you wish to generate by 22 and 28.

Multiplying these figures results in a portfolio dividend yield (annual dividend income divided by portfolio market value) of 3.5% to 4.5%.

Within that dividend yield range, we believe you can build a conservative dividend portfolio without sacrificing business quality, income security, or sector diversification. Over time, we expect this portfolio to deliver mid-single-digit annual dividend growth.

Using an example from the United States Bureau of Labor Statistics, total annual expenditures in 2014 averaged $49,279 among older households. After adjusting for inflation, this equates to approximately $62,000 in 2022.

If dividends were the only source of income for this family, they would need a portfolio worth between $1.4 million ($62,000 x 22) and $1.8 million ($62,000 x 28), assuming a starting dividend yield of 3.5% to 4.5%.

However, it is likely that this couple has other sources of income, which reduces the amount of dividends required in retirement.

The Social Security Administration, for example, estimates that two-thirds of retirees will receive the majority of their income from Social Security payments. As of 2022, retired workers and their spouses received an average monthly benefit of approximately $2,500 ($30,000 per year).

While some of this Social Security income would almost certainly be taxed, these benefits could potentially cut in half the size of the portfolio needed to help this household live off dividends.

Pension income, annuities, and other sources of income can help to reduce the amount of supplemental dividends required in retirement.

How to Get Started with an Investment Portfolio for Your Retirement

The sum of money that you have set aside for a dividend investing approach has the potential to be spread out among a variety of different equities and funds.

Mutual funds and ETFs that pay dividends are simple to use, have modest maintenance fees, and offer quick diversification. The majority of the time, investments in funds can be made and then forgotten about.

Nevertheless, investors in funds forfeit a significant advantage, namely control.

The majority of funds have holdings consisting of dozens, hundreds, or even thousands of different equities. For instance, Vanguard's High Dividend Yield ETF (VYM) has ownership in nearly 400 different firms.

Some of these companies are solid and have dividends that are certain to be paid out, while others are of poorer quality and are more likely to reduce or eliminate their payouts in the event of an economic slowdown. There are some with very high yields, while others produce very little in the way of income at all.

To put it more simply, a fund is a collection of different companies that may or may not meet the income requirements and risk tolerance that you have set for yourself, especially when the tide goes out.

During the global financial crisis that lasted from 2007 to 2009, Vanguard's High Dividend Yield ETF ran into difficulties since it did not prioritize dividend safety. During this time period, the dividend income from the ETF had a decrease of 25%, and it took four years for it to recover to its previous level.

Because the dividends on most funds are variable, meaning they change in an unpredictable manner from period to period, it can be difficult to estimate how much money you will bring in on any given month.

Although these are not always reasons to avoid funds, selecting your own dividend stocks can make it simpler to adjust the amount of risk in your portfolio and provide you more insight into your income stream. This is one advantage of doing so rather than investing in mutual funds.

The vast majority of businesses hand out dividend payments on a quarterly or monthly basis in predetermined quantities. You won't be in the dark about how much money you're making from each stock or when it will be paid out.

When compared to investing in most funds, selecting your own holdings with a focus on dividend safety has the potential to offer an income that is both greater and grows at a faster rate. In addition, you will have a better understanding of all of the investments that you now possess, which will make it easier for you to withstand the next market downturn.

The following are some of the general parameters that we like to follow when constructing a portfolio:

• Holding between 20 and 60 equities can help lessen the risk associated with individual companies.
• Because it is difficult to predict which companies will have the best long-term performance, you should give roughly equal weight to each position.
• You should not invest more than 25 percent of your portfolio in any one industry.
• Focus on businesses that have either a Safe or Very Safe Dividend Safety Scores.

You are free to modify those recommendations to fit your risk tolerance and the objectives you wish to achieve. For instance, let's say you don't mind taking on somewhat more danger and are ready to increase the number of equities you own that have Borderline Safe Dividend Safety ScoresTM. Or perhaps you are looking for a portfolio that has an average yield that is close to 4%.

Having said that, it is important to be aware of a number of potential dangers if you plan to fund your retirement on dividend income.

Common Mistakes to Avoid

Dividend strategies can create the temptation to invest primarily in high-yielding stocks, which provide higher income today but are concentrated in a few industries such as utilities, energy and master limited partnerships (MLPs).

A portfolio that bets heavily on these areas of the market without proper diversification may be more sensitive to rising interest rates, be hit harder by any industry-specific adverse developments, and generate total returns that deviate significantly from the broader market.

And, outside of dividend-paying industries such as REITs and MLPs, high yields can indicate that something is structurally wrong with a company or that the dividend needs to be cut to help the company survive. These circumstances can lead to a permanent loss of capital.

Aside from chasing yield, dividend investors can also fall victim to hindsight bias.

The desire to own consistent dividend growers has led to the popularity of groups of stocks such as the S&P 500 Dividend Aristocrats among investors. Dividend aristocrats are S&P 500 stocks that have increased their dividend for at least 25 years in a row.

Dividend investors are interested in these stocks because they have outperformed the market. We like to believe that they will always pay and grow their dividends, but this is not guaranteed.

During the financial crisis, 16 of the 60 dividend aristocrats that existed in 2007 cut or suspended their dividends. While bank stocks accounted for the majority of those losses, it's never easy to predict which industry will be hit next.

The pandemic was the most recent reminder that dividend income is not without risk. With the United States' economy contracting at its fastest rate in history, 25% of companies covered by our Dividend Safety ScoresTM (333 out of 1,313) cut dividends in 2020.

This does not invalidate dividend investing, but rather emphasizes the importance of owning companies with solid balance sheets and proven operations. These are the companies that are more likely to maintain their payouts in good and bad times.

The bottom line is that dividends are fraught with danger. Investors pursuing this strategy in retirement should monitor their portfolios' dividend safety, make adjustments as needed, and diversify their holdings.

Finally, dividend investors can fall into the trap of focusing on income return rather than total return (income and price return).

Just because a stable company pays a dividend doesn't make it a better investment or more resistant to stock market price drops. In theory, it shouldn't matter whether your retirement cash flow comes from dividend income, bonds, or the sale of your portfolio's holdings.

However, from a behavioral standpoint, leaving principal alone and living off the dividends generated each month can help investors tune out the noise caused by fluctuating stock prices.

Furthermore, if the stock market experiences a significant correction during the early years of retirement, dividend investors are less vulnerable to sequence of returns risk because they do not need to sell more shares in response to lower stock prices.

Conclusion

Retirement asset management can be overwhelming. Your financial condition, long-term goals, risk tolerance, and quality of life expectations affect many significant decisions.

Always evaluate the fees, flexibility, and fine print of investment methods. You're aiming to reach a steady cash flow goal and aren't wed to accomplishing it through bond interest, annuity payments, asset sales, or dividend income.

Quality dividend stocks can boost a retirement portfolio's income and return. A well built basket of dividend companies can help investors stay the course and make a retirement portfolio last a lifetime.