Have you ever heard of the term passive income, and figured you may as well get yourself a slice of that cake. Well, dividends are one of the more effective methods of passive income.
We will discuss some of the things you need to consider if you want to live off dividends. We also recommend you seek out advice from a professional advisor.
Or you can go for different types of passive income like renting property or collecting interest from bank accounts.
But renting property requires actually owning the property and bank interest doesn’t earn much (Find out How Many Rental Properties To Retire?).
The joy of dividends is that you can start at the comfort of your own home and all you need is an internet connection. But how much do you need to live off dividends alone?
Unfortunately, there isn’t a set answer. Everyone’s amount will be different depending on the lives they lead.
Someone who owns their house already and has no dependents will need less than someone with children and rent.
We can help you calculate your personal amount and help you understand the ins and outs of dividends.
One thing to know before you get started on your journey is that the stock market is a fickle thing. It can change quickly and without warning so proceed with caution. Let’s get started!
What Are Dividends
Dividends is the distribution of a company’s profit to a class of its shareholders.
This amount is usually given every quarter and is determined by the company’s board of directors. Most dividends are paid in cash but sometimes it can be in shares for the company.
What Is A Dividend Yield?
A dividend yield is the annual dividends per share divided by the current share price. You then times that by 100 to get a nice whole number.
For example, if a company pays $3 per share and the current share price is $80 then the company’s stock has a dividend yield of 3.75% (3/80=0.0375 0.0375*100=3.75).
How Much Money Do You Realistically Need?
First you need to understand your current financial situation. Try to keep an accurate track of them so you know how much you want your dividend goal to be.
You can do this with the old-fashioned pen and paper, or you can use a budgeting program.
Either keep track of your expenses and adjust accordingly to the amount you’re happy with, or you can just take your annual income from your current job and start there.
Even though we are aiming high for the amount we want to earn, it’s important to set a realistic goal first to keep us on track.
When you get this annual spending amount you can divide that by the dividend yield of your intended portfolio.
This will give you a rough idea of how much money you need to invest in order to live comfortably.
To put that into perspective, the average US house will need to invest about $1.5 million, again this will be different for every person.
However, don’t be put off by that large figure. If you live frugally and reinvest all your dividends at the start you can reach your goal faster than you think.
Realistically, you can expect the dividend yield to be 1-6 percent, So we recommend using 3% or 4% when doing your own calculations.
An example would be if you plan to spend $50,000 a year and believe your portfolio can give you 3% yield then you can find the portfolio value at $1,666,666 (50,000/0.03=1,666,666).
Understanding Dividend Sustainability
When looking at potential investments, don’t be tempted by the highest yields (those around 10%) as they could be the riskiest.
When the stock goes down the dividends yield will usually rise as the company would want people to invest in them.
Instead, look for a company that is steadily growing and see its previous dividend yields.
When you begin your journey try to reinvest all your dividends to grow your wealth faster.
When you have reached your goal amount then you can start taking the amount as cash in order to pay for expenses.
What Taxes Do You Pay On Dividends?
When doing your calculations remember to include taxes. Dividends are usually taxed in 2 ways.
- Qualified – Taxed at the lower long-term capital gains tax rate.
- Non-qualified or Ordinary – Taxed at the short-term capital gains tax rate. This amount is usually more than the qualifying amount.
To qualify, the dividends must be paid by a:
- US-owned company.
- Company in US possession.
- Company in a country that is eligible for benefits under US tax treaty.
- Foreign company stock that can be easily traded on a major US stock market.
Shareholders must also meet holding period requirements in order to be eligible for qualified tax rates.
You won’t have to pay tax on your dividend stocks if they are in a tax-advantaged retirement account. Great for those looking into early retirement.
Is It A Good Idea?
For many people, dividends have been a good investment strategy. But don’t get down if what works for them doesn’t work for you.
You can read a thousand articles but you won’t know what is effective for your lifestyle until you get started.
When looking into your potential investment portfolio, consider all of the pros and cons.
Your portfolio will need to be quite large in order to earn any real money and if it is your own source of income it could be risky.
Dividends aren’t a get-rich-quick scheme. In order to benefit from them, you need to be consistent and have a good strategy going into it.
It will take a while before you see any results but if you’re patient you can soon have your money making you more money while you retire and live your life to its fullest.