Living Off Dividends: How to Use Passive Income to Cover Your Expenses

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Living Off Dividends

Being able to live off of your investments is a dream for many people. Not needing to work for income or to withdraw money from your investments would be the ultimate in terms of financial freedom.

Although it’s a dream, it’s also a realistic possibility with the right combination of time and discipline.

In this article, we’ll look at all of the details surrounding the topic of investing for dividends and ultimately getting to the point of living off dividends.

What Are Dividends?

When a company earns a profit, it can reinvest that money into the business (with the hope of growth), or it can distribute the profit to shareholders in the form of dividends. In reality, many companies do both. They may reinvest the majority of profits back into the business while using some of the profits to pay dividends to shareholders.

Shareholders can either take the dividends as cash, or they can be reinvested to buy more shares of the company. Of course, if you’re living off dividends, you would be taking this money as cash and using it for your living expenses instead of relying on a source of income like a job.

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What It Means to Live Off Dividends

Living off dividends and passive income streams is an alternative to withdrawing money from your investment balance to cover living expenses in retirement. If you’re able to live off of dividends and the value of your investments never decreased, you’d be able to live off dividends indefinitely. As long as your living expenses remain below the amount you earn in dividends, you’ll be able to preserve the capital of your investments.

Of course, the cost of living increases as the years go by, which means your dividend income will need to increase as well if it’s going to cover all of your expenses. Thankfully, many companies continually increase the dividends they pay, and these increases often outpace the inflation rate. If you’re investing in the right companies, the dividend income growth should more than cover for inflation.

While it would be great to be able to live off dividends, don’t overlook the fact that living off dividends is only one option. Even if you’re never able to cover 100% of your living expenses with dividend income, it’s possible that a smaller amount of passive income will still have a life-changing impact.

For example, generating $1,000 – $2,000 per month from your investments may not cover all of your living expenses, but maybe it’s enough that you can retire a few years earlier. Or maybe you combine your dividend income with money you make from a side hustle so you’re able to leave your full-time job.

Living off dividends may be one of your financial goals, but there’s still a lot to gain even if you don’t reach the goal.

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What Types of Investments Pay Dividends?

  • Stocks – The most popular option for dividend investors is individual company stocks. These are usually large, very well established and recognizable companies that have long track records of paying dividends to shareholders.
  • Mutual Funds – Some mutual funds will also pay dividends. These mutual funds invest in stocks that pay dividends, which ultimately gets passed on to the investors (minus the management fees).
  • ETFs – Similar to mutual funds, there are also ETFs (exchange-traded funds) that include dividend-paying stocks and pass those dividends on to investors.
  • REITs – REITs (real estate investment trust) allow you to invest in real estate without the need to own or manage property. Investing in REITs is also a great way to earn dividends. Real estate crowdfunding and eREITs are also solid options. For example, Fundrise has a supplemental income portfolio for investors who want consistent annual income while earning a solid rate of return.

Most of the information you’ll read online about dividend investing will be focused on individual stocks. Even some of the other options, like mutual funds and ETFs, ultimately invest in dividend-paying company stocks. But other types of income-producing assets may also present options.

Investment Platforms

Our highest-recommended platforms are Public.com, M1 Finance, and Unifimoney. With any of these platforms, you can easily invest in stocks and ETFs that pay dividends. Public.com even offers a helpful list of stocks and ETFs that pay dividends so you can easily find ideal investments that match your goals.

You can also purchase fractional shares, which means you can own any stock or fund regardless of the stock price.

Later on in the article, we’ll look at how much you need to invest to generate specific levels of passive income from your portfolio. The best approach is to choose one of these platforms, get started now, and add money on a regular basis to continue growing your portfolio.

Dividend Reinvestment Plan

A dividend reinvestment plan (DRIP) gives you, the investor, the option to have dividends automatically reinvested. Many brokerages provide this option. With Public.com, all you need to do is go to your account settings and flip the toggle if you want dividends to be automatically reinvested.

If you’re currently in the phase of growing your investments, you’ll want to enable this option. Once you reach the phase where you’ll use the dividend income for living expenses, you can turn the automatic reinvestment off and take the dividends as cash.

Active Income vs. Passive Income

Dividends are attractive because they’re passive income. You don’t have to do any work for the money you earn as dividends, it’s simply a result of your investments.

Active income is money you make as a direct result of your work (like a typical job or a service you provide if you’re self-employed). Passive income doesn’t require your time or effort.

Most types of passive income require either, 1) money to invest, or 2) time and effort upfront in order to set up the passive income stream. A dividend strategy falls into the investment category.

If you want to be able to break free from the requirement to work for a living, you should be focused on creating streams of passive income.

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How Much Money Do I Need?

Let’s take a look at the size portfolio you’ll need to live off dividends. The table below shows how much you’ll earn (at 3% and 4% annual dividend yield with a portfolio of $500,000, $1 million, and $2 million.

Of course, the income produced by a portfolio of $500,000 is not enough to completely cover the living expenses for the average person, but it can go a long way towards reducing the annual income you need from other sources. The average person would need to build a portfolio of at least $1 million to fully cover living expenses with dividend income. A portfolio of $2 million would produce an amount that provides a comfortable lifestyle for most people.

Portfolio Size

$500K

$500K

$1M

$1M

$2M

$2M

Dividend Yield

3%

4%

3%

4%

3%

4%

Annual Dividend Income

$15K

$20K

$30K

$40K

$60K

$80K

Living Off Dividends Example

Now, let’s take a look at how this might play out. The average household income in the United States is estimated to be around $66,000 (source). The average retired household spends about 25% less in retirement than they did while working (source), which is typically accounted for in retirement planning.

Keeping these numbers in mind, let’s use $50,000 of annual income as the guide of what will be enough to cover living expenses in retirement. It may be more or less for you, but this is a good starting point.

To generate $50,000 of annual dividend income, you would need a portfolio of $1.25 million with an average dividend yield of 4%.

If you’re receiving social security, that will reduce the amount needed from your dividend strategy. The average social security benefit is around $17,000 per year (source). To generate the additional $33,000 from passive dividend payments ($17,000 social security + $33,000 in dividends = $50,000 for living), you would need a portfolio of $825,000 with an average dividend return of 4%.

Side hustle income could also reduce the amount needed from dividends. So as you can see, it’s very possible to combine dividends with other supplemental income to cover living expenses, even if you’re not able to live 100% off of dividend income.

Living Off Dividends is a Long-Term Goal

Reaching financial independence is not a short-term goal. If you want to live off dividends, you’ll need a long-term focus and you’ll have to stick with it. You’ll need to consistently work to build up your investment balance and give those investments the time they need to grow and compound.

As we saw in the example above, living off dividends is a realistic goal, but it’s not easy to achieve. You’ll need a significant investment balance before you’re able to cover your expenses with the investment income, but if you keep working towards that goal each month for several years, it’s very achievable.

Pros and Cons of Dividend Investing

Although this article focuses on how you can create and grow dividend income, it’s only fair to point out the pros and cons of income from this dividend strategy. We want to be sure to take a balanced approach, so be sure to consider these pros and cons.

Pro #1: Source of Passive Income

The most obvious reason to choose investments that pay dividends is the possibility of passive income. Passive income is really what this article is all about, and that’s the primary motivating factor for many dividend investors.

The ultimate level of financial freedom is being able to pay for your living expenses with the passive income generated from your investment balances, without dipping into the investments and withdrawing from the balance.

Pro #2: Can Be Reinvested

Just because your investments are paying dividends doesn’t mean you need to take that money and use it for your living expenses. The ultimate goal is to be able to earn enough in dividends to cover all of your expenses, but as long as you’re working and able to support yourself, you should be reinvesting those dividends to grow the asset.

In fact, reinvesting is a major part of the process of growing your portfolio. The stock dividends you reinvest will be used to purchase more shares and those additional shares will earn more dividends for you, so it keeps growing (ideally).

When you get to the point that you want to use the dividends for some or all of your living expenses, you can simply elect to turn off the reinvesting and start taking the dividend payouts.

Pro #3: Many Companies Increase Their Dividends Over Time

Many of the most popular individual dividend stocks have consistently increased the dividends they payout over time. In fact, dividend increases may even outpace the effects of inflation.

Dividend kings and dividend aristocrats are companies that have a proven track record of paying out and increasing dividends. These should be the cornerstone of your dividend portfolio.

Pro #4: Generally Considered Safer Than the Stock Market as a Whole

A portfolio of dividend stocks is generally considered to be safer as compared to investing in the market as a whole. These quality companies tend to have long histories and are very well established, making them more conservative with lower investment risk. The price of the stock may grow slower than some smaller companies, but they’ll also be likely to provide more protection during a downturn.

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Con #1: Taxes

Dividend income is taxable income. The amount that will be taxed will depend on a few factors, like whether the dividend payments are qualified or unqualified (see this article for details). If you own company stocks that don’t pay dividends, you can control when you sell the shares of stock and pay taxes. With dividends, you have less control.

Related reading: How to Pay Zero Tax on Passive Income

Con #2: Growth is Not Guaranteed

Ideally, the stocks or funds you purchase will increase in value while also paying out dividends. However, like other stocks and investments, there’s no guarantee of growth. It’s possible your investments could lose value. However, one of the reasons why investors love dividend stocks is because these well-established companies have a long track record and tend to perform well.

Con #3: Can Lead to a Lack of Diversification

A lot of the most popular dividend stocks come from the same sectors, and they’re generally large companies. If you’re only investing in stocks for dividends, you’re probably not getting a great deal of diversification in your portfolio of stocks. You may want to account for this and invest in some other ways to get proper asset allocation, rather than having all of your money in the same types of company stocks or funds.

Getting Started with Dividend Investing

If you decide you want to invest for dividend earnings, there are basically two ways you can go about it:

The do-it-yourself approach will involve researching stocks and developing your own criteria that you’ll use to choose the stocks you want to buy. You’ll be in full control, but it will take some time. If you haven’t done it before, you’ll need to get comfortable with the process and educate yourself in order to have success.

The second, and easier option is to invest in mutual funds or ETFs that focus on dividends. You can spend just a small amount of time researching a few options, make your choice, and then you won’t need to do a lot of ongoing work or research aside from occasionally checking on the initial investment.

Public.com provides a list of suggested ETFs in its dividend theme. So all you need to do is look at the different ETFs they feature and choose the ones you want to invest in. Then, you’ll simply focus on adding more money to your investment. You won’t need to constantly evaluate individual companies and decide which ones should get your investment. Instead, you’ll simply pick a fund and continue to buy more shares whenever possible.

Here are the specific steps you can take.

Step 1: Open a Brokerage Account and Fund It

The first step is to open a brokerage account. We like and recommend Public.com because:

  • They offer commission-free trades of stocks and ETFs
  • With the DRIP settings you can automatically reinvest dividends or take them as cash
  • They provide a helpful list of dividend-paying stocks and ETFs in their dividends theme
  • Their platform is very easy to use
  • Low minimum investment ($1)

Of course, there are other options as well, like Unifimoney, M1 Finance, and Robinhood.

Once you have the brokerage account opened, you can transfer money from your bank account to start investing.

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Public.com offers fractional shares and commission-free trades of stocks, ETFs, and crypto. You'll love the social aspect that makes it possible to connect with other investors. Get a free bonus when you open an account through our link. Offer valid for U.S. residents 18+ and subject to account approval. This is not a recommendation. You can lose money with any investment. Open To The Public Investing is a member of FINRA & SIPC. Regulatory and firm fees apply. See Public.com/disclosures/.

Step 2: Research

Once you have the account opened, you’ll need to start researching to determine which stocks or funds you want to buy. The criteria for these investment decisions is far too big of a topic to cover in this article, but thankfully Public.com makes it easy with their suggestions in the dividend theme. You’ll find a list of stocks and ETFs that are ideal for dividend-focused investors.

Step 3: Buy Stocks and Funds That Meet Your Criteria

After you’ve done some research and analysis to find stocks and funds you want to invest in, you can go ahead and use your brokerage account to make those investments. It doesn’t have to be a large amount to get started. Most platforms, including Public.com, Robinhood, and M1 Finance allow you to start with as little as a few dollars, so you don’t need a lot of capital to get started.

Step 4: Reinvest

This is a key part of the process. You want to reinvest the dividends to buy more shares for as long as possible. Reinvesting will drastically speed up your progress as you’ll be using the dividends to buy more shares that produce more dividends, and so on.

Don’t take the dividends as cash until you need to, and put it off as long as possible.

Step 5: Continue Adding to Your Investments

Reaching the point where you’re able to live off of dividends will require a large portfolio, and to achieve that, you’ll need to add to your investments on a regular basis. Your investment strategy should include a goal that you want to contribute each month. Put it in your budget like any other expense. Make it a priority to invest this money every month and you’ll see your portfolio grow faster than you expected.

Step 6: Turn Off Reinvesting and Live Off the Dividends

Once you reach the point where you’re earning enough in dividends to cover your living expenses, you can stop reinvesting and use that dividend income stream to cover your expenses. Of course, if you’re able to continue reinvesting even longer, that’s great! But the cash payment is ultimately the purpose of this strategy.

Fundrise: An Alternative to Stocks

Fundrise

While stocks, mutual funds, and ETFs are the most common ways to invest for dividends, there are some other options. Fundrise is the most popular real estate investing platform and it’s an excellent asset for those who want to generate cash flow from their investment portfolio.

As a Fundrise investor, you’ll own a share of a portfolio of income-generating properties (apartment buildings, condos, office buildings, etc.). You won’t need to research properties or choose individual investments. Fundrise handles all of those details.

Fundrise pays investors quarterly, and you have the option to reinvest the dividends or take the cash payout. There’s a setting in your profile and you can easily change the setting at any time.

In addition, Fundrise offers a few core strategies: supplemental income, long-term growth, and balanced. If your goal is to live off dividends, the supplemental income strategy will help to maximize the cash flow that’s generated from your investment.

Fundrise also have a very helpful goals feature. You can set a goal of a certain amount of income you want to generate from your investments, and it will tell you how much you should be adding to your account on a regular basis to reach that goal.

For those who want to add some diversification and create a balanced portfolio, Fundrise is an excellent option that has historically provided a solid return on investment.

Keys to Success

Here are a few things that will be very important to your success as an investor with the goal of living off dividends.

1. Eliminate Debt

Debt is the enemy. By paying off your debt, your monthly living expenses will be lower, which reduces what you need to earn from dividends. You’ll also avoid paying high interest rates on credit cards and personal loans. If you have debt, aside from a mortgage, paying it off should be a top priority.

2. Set Spending Limits

Do you know how much money you need for monthly or yearly living expenses? Most people don’t. Setting spending limits in your financial plan will help you to keep your expenses under control, and it will also give you a target. For example, if your spending limit is $50,000 per year, that shows you exactly how much you need to be able to earn from dividends on an annual basis.

3. Start Investing Early

If you’re wondering when is the best time to start, it’s now. It’s never too early to start, and having more time will make your chances of success a lot higher.

4. Be Consistent

Starting early is great, but you’ll also need to keep saving and adding more to your investments. Take a consistent approach where you save money every month to add to your investments. With a consistent, long-term approach, you’ll be well on your way to success.

5. Increase Your Income

One of the best things you can do for your investing success is to increase your income so you’ll be able to invest more or make more frequent contributions.

There are several realistic ways to increase your income. You could:

  • Get a raise at your current job
  • Get a promotion
  • Work overtime
  • Find a higher-paying job
  • Start a side hustle
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Frequently Asked Questions

How Much Money Do You Need to Live Off Dividends?

The answer to this question depends on how much you spend each year and what dividend yield your investments produce. For example, if you need $40,000 per year for living expenses and your investments produce an average dividend yield of 4%, you’ll need to have $1 million invested to produce $40,000 in dividends.

How Do I Make $500 Per Month in Dividends?

If you’re investments earn 3% dividend yields on average, you’ll need a portfolio of $200,000 to produce $6,000 per year ($500 per month). If your investments earn 4% dividend yields, you’ll need a portfolio of $150,000.

How Much Do I Need to Invest to Make $1,000 Per Month in Dividends?

If you’re investments earn 3% dividend yields on average, you’ll need a portfolio of $400,000 to produce $12,000 per year ($1,000 per month). If your investments earn 4% dividend yields, you’ll need a portfolio of $300,000.

Do People Make a Living Off Dividends?

Yes, some people are able to cover their living expenses with dividend income. It’s not easy and it takes a long-term focus, but it’s definitely possible.

Can You Lose Money on Dividend Stocks?

Yes. Dividend stocks, just like other stocks and investments, can lose value.

How Do You Know if a Stock Pays Dividends?

Public.com offers a dividend theme that provides a list of stocks and ETFs that pay dividends. You can also check the stats on any financial platform and see the dividends that have been paid out.

Closing Thoughts

Living off dividends can be a realistic goal, although it won’t be easy. Keep in mind that you don’t have to completely live off dividends to have success. This approach is also very effective when it’s combined with other sources of income (like social security, a pension, or a side hustle).

READ NEXT: 9 Steps to Financial Independence (How to Retire Early)




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