Can You Live off Dividends?
Can You Live off Dividends?
The reality is, yes, you can live off dividends as your only source of income for retirement. However, only a small percent of the population can invest this way.
It requires a large amount of money of around roughly 1 – 2 million dollars to receive a decent amount of dividends to live sufficiently.
Trying to retire with dividends is challenging, and depending on your situation, it may not be worth the amount of money. Selling your investments may be a better option than accumulating dividends.
You will need to find the right balance between equity and debt percentage in your portfolio to get a rough estimate of how much you will make in dividends.
Typically equity pays a higher return than debt investments. However, the drawback is a company can choose not to pay out dividends, and there’s the possibility the business will fail and defaults on paying dividends.
Debt investments offer a lower investment interest return than dividends. It’s a rare chance of defaulting on payments should a business fail.
Dividend Yield
To find how much you’ll receive in dividends from a company, you look for the dividend yield. The dividend yield is the annual dividend payments expressed as a percentage relative to the current price.
(Annual Dividends per Share / Current Stock Price) = Dividend Yield
Assuming you own $1,000.00 in Microsoft stocks and the dividend yield is 1.60%. You can find how much you’re expecting to earn. Take 1.60% and convert it into a decimal of .016, then multiple by $1000.
.016 * 1,000 = $16 per year ($4 per quarter)
$16 is the expected amount of annual dividends you’ll receive assuming Microsoft stocks remain the same price. Dividends are typically paid out quarterly and you would receive $4 per season that adds up to $16.
It’s never the case a stock price will be the same as the start of the year. A stock price is volatile and can easily change at any period.
Dividend Industries
Industry sectors will vary on dividend amounts, but more importantly, research the company’s dividend performance. Research companies that have long and steady records of dividends paid out.
It’s a good indicator that a company can withstand most financial difficulties and still payout shareholders without reducing or eliminating dividend payments.
Top Industry Sectors that Pay High Stable Dividends:
- Utilities – Electric, Water, Natural Gas (Suppliers)
- Energy – Oil, Natural Gas (Producers)
- Consumer Staples – Food & Beverage, Household Items, Retail Products
- Real Estate Investment Trusts (REITs) – Real Estate
Utilities are essential to basic human needs, but the stock price stays relatively the same and makes it up by offering high dividend yields.
Most energy companies are master limited partnership (MLP) business venture. As an MLP, they pay out all of their profits to shareholders to maintain tax-advantaged benefits.
Consumer staples historically paid out high dividend yields as stock price increase slightly but can withstand recessions.
REITs follow a similar process as energy companies that are MLP to most of their profits to shareholders to maintain tax-advantaged benefits.
The main reason why these industries can pay higher dividends than other industry sectors is that they provide a stable income. These industries are predictable with how they make their revenue and earnings.
If a company can get an accurate estimate of its financials, it can plan how much to reinvest in the business and give more profits to shareholders. Even in times of financial difficulties, these sectors will remain in business because everyone needs to have them.
Be careful when purchasing high dividend-paying companies. A company can use high dividend yields to steer you away from looking at the stock price dropping.
A company may choose not to give out dividends due to poor business performance. Investors then will be stuck with a bad investment without dividend payments and stock price dropping in value.
Dividend Example
Let’s illustrate an example of how much money you need if you want to receive $50,000 from dividends alone annually.
We will be using the average dividend yield for the S&P 500 of 2020 at 1.97%. We convert 1.97% to a decimal of .0197 for calculation.
(50,000 / .0197) = $2,538,071.07 dollars
It takes 2,538,071.07 dollars to make $50,000 off dividends alone, assuming your overall dividend yield is 1.97%.
Most people don’t have that much saved up to invest. By the time you have this amount, it may not be worth making $50,000.
Cons of Dividends
If you choose to build wealth through dividends, recognize there will be cons of doing this. You’ll need up to 1 million or more dollars to have enough money to sustain yourself.
It won’t be a lavish lifestyle, but enough to get you by for decent living expenses.
Stock picking dividend performing companies is difficult. You will need to monitor dividend stocks you own as previous well-performing dividend stocks can fail later on.
General Motors was previously a high performing dividend stock but cut it’s dividend payments and declared bankruptcy in 2009. The government bailed out General Motors and saved it from failure.
You will owe taxes on the dividends you receive. The amount you owe will vary if they are ordinary dividend income or qualified dividend income.
Ordinary dividend income adds the amount into your ordinary income, and you will owe the amount depending on your tax bracket.
Qualified dividends meet specific criteria that fall within the Internal Revenue Service (IRS) guidelines. Qualified dividends owe less on taxes than ordinary dividend income. The amount you’ll pay on taxes can be 0%, 15%, 20% depending on your income level.
According to the IRS, a dividend must meet these criteria to be a qualified dividend:
- The dividend must have been paid by a U.S. company or a qualifying foreign company.
- The dividends are not listed with the IRS as those that do not qualify.
- The required dividend holding period has been met.
Dividend income can be a great source of income, but examine the cost that comes with it. Evaluate your portfolio and consider other ways to invest your money. Don’t focus on only one source, but diversify to reduce your risk of lowering your portfolio value.
