Being able to live off of our investments is a dream for many of us. No need to rely on working for income, and not even needing to withdraw money from your investments would be the ultimate in terms of financial freedom.
Although it is 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 that surround the topic of investing for dividends and ultimately getting to the point of living off dividends.
What Are Dividends?
When a company has 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 will do both. They may reinvest the majority of profits back into the business while using some of the profits to pay dividends to the 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 are living off of dividends, you would be taking this money as cashing and using it for your living expenses instead of income from a job.
Living off dividends is an alternative to withdrawing money from your investments in order 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 of dividends indefinitely, as long as your living expenses remain below the amount you earn in dividends.
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. Keep in mind that dividends are not magical money that appears from out of nowhere. Money that companies use to pay dividends to shareholders is money that those companies are not reinvesting into the business. This means that those companies may grow slower than they would if they were reinvesting more money into the business.
Most smaller companies that are 100% focused on growing will not pay dividends because they reinvest as much as possible to try and grow faster. If they are successful, the result is a higher share price. The higher share price can lead to a bigger portfolio for your investments, even if no dividends are paid.
Withdrawing from your investments isn’t necessarily a bad thing. It’s possible that your investments could be growing even more than you are withdrawing.
How Much Money Do I Need?
|Annual Dividend Income||$30,000||$40,000||$60,000||$80,000|
What Types of Investments Pay Dividends
Let’s take a look at some of the most popular types of investments that can pay dividends:
- Stocks – The most popular type of investment for dividends are individual stocks. These are usually large, very well established and recognizable companies.
- 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). You can see a list of some of the top dividend-paying mutual funds here.
- ETFs – Similar to mutual funds, there are also ETFs (exchange-traded funds) that include dividend stocks and pass those dividends on to investors. You can see a list here.
- 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, and there are a number of REITs that pay out significant dividends. Real estate crowdfunding and eREITs are also popular investments that pay dividends. For example, Fundrise has a supplemental income portfolio for investors that want dividends.
Most of the information that you’ll read online about dividend investing will be focused on stocks. Even some of the other options, like mutual funds and ETFs, ultimately invest in dividend-paying stocks.
Active Income vs. Passive Income
Dividends are attractive because they are passive income. You don’t have to do any work for the money that you earn as dividends, it’s simply a result of your investments.
Active income is money that you make as a direct result of your work (like a typical job or a service that 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 up front in order to set up the passive income stream. Dividends fall 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.
→ Related reading: Best Passive Income Ideas
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 that there are pros and cons to income from dividend investments. We want to be sure to take a balanced approach, so consider these pros and cons.
Pro #1: Source of Passive Income
The most obvious reason to choose investments that pay dividends is the possibility for passive income. The passive income is really what this article is all about, and that’s the primary motivating factor for many people who want to earn dividends from their investments.
Pro #2: Can Be Reinvested
Just because your investments are paying dividends doesn’t mean that 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 that it will cover all of your expenses, but as long as you are working and able to support yourself, you should be reinvesting those dividends.
In fact, reinvesting is a major part of the process of growing your portfolio. The dividends that 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 dividend stocks have consistently increased the dividends that they pay out over time. In fact, dividend growth may even outpace inflation.
Dividend kings and dividend aristocrats are companies that have a proven track record of paying out and increasing dividends. These are the cornerstone of many portfolios that focus on dividend investing.
Pro #4: Generally Considered Safer Than the Market as a Whole
Dividend stocks are generally considered to be safer investments as compared in investing in the market as a whole. These companies tend to have long histories and are very well established, making them more conservative investments. They may grow slower than some smaller companies, but they’ll also be likely to provide more protection during a downturn.
Con #1: Taxes
Dividend income is taxable income. The amount that it will be taxed will depend on a few factors, like whether the dividends are qualified or unqualified (see this article for details). If you own stocks that don’t pay dividends, you can control when you sell the stock and pay taxes. With dividends, you have less control.
→ Related reading: How to Pay Zero Tax on Passive Income
Con #2: Dividends Are Not Guaranteed
Most investors who are after dividends will select stocks or other investments that have a history of paying dividends. History can be a key indicator of what is likely to happen in the future, but there is no guarantee that the investment will continue to produce dividends, or that the dividends may not be reduced.
Con #3: Growth is Not Guaranteed
Likewise, the growth of the value of the investments is also not guaranteed. In some cases, a company could be very aggressive with the dividends that are paid out, to the point that it hurts the growth of the company and the value of the share is decreased.
Con #4: Can Lead to a Lack of Diversification
A lot of the most popular dividend stocks come from the same sectors, and they are generally large companies. If you’re only investing in dividend stocks, you’re probably not getting a great deal of diversification in your portfolio.
Two Approaches to Dividend Investing
If you decide that you want to invest for dividends, there are basically two ways that you can go about it:
The do-it-yourself approach will involve researching stocks and developing your own criteria that you will use to choose the stocks that 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.
If you’d like to invest in dividend stocks but you don’t have the time to do the research on your own, or if you’re just unsure about your ability to analyze and pick stocks, you could use Emperor Investments to automate the process.
Emperor Investments is a robo advisor that focuses exclusively on stocks. You’ll answer some questions related to your investing timeframe and your tolerance for risk. Emperor Investments will use that information, as well as goals that you set up, to create a portfolio of dividend stocks that is customized for you.
I’ve been a client of Emperor Investments since late 2018, because I don’t feel like I have the time to do a good job with my own research. So far, I’ve been very happy with it. The annual fee is 0.6%, which is higher than other robo advisors, but since all of your investments are in stocks, there are no other hidden fees like mutual fund management fees. Their track record is impressive, so if that success continues, the fee is well worth it. (If you sign up through this link, you’ll get six months with no fees.)
Another simple option is to select a mutual fund or ETF that will produce 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 on-going work or research aside from occasionally checking on the investment.
The last simple option that we’ll look it is to invest in Fundrise. With a minimum investment of $1,000, you can get started with their supplemental income portfolio. You’ll be investing in a portfolio of properties that will ideally produce growth in your investment, as well as consistent dividends. The dividends can be reinvested or taken as cash, and you can change that setting any time. Fundrise charges an annual fee of 0.85%.
The automated options are simple, and you can get started almost immediately. The DIY approach definitely involves more work, but we’ll look at the specific steps below.
DIY Step 1: Open a Brokerage Account and Fund It
If you decide that the DIY approach is right for you, the first step is to open a brokerage account. You can use an app like Webull or Robinhood (both offer free trades on stocks and ETFs), or a popular online brokerage like Fidelity ($4.95 per trade).
Once you have the brokerage account opened, you can transfer some money from your bank account to start investing.
For a limited time, you can get free stocks from Robinhood and Webull. Get a free stock for opening a Robinhood account here. With Webull, you’ll need to make an initial deposit of at least $100, but you’ll get a stock valued at $8 – $1,000. Sign up with Webull here.
DIY Step 2: Research
Once you have the account opened, you’ll need to start researching to determine which stocks you want to buy. This topic is far too big to cover in this article, but if you’re looking for some direction, you can check this series of 18 articles that covers dividend growth investing.
DIY Step 3: Buy Stocks That Meet Your Criteria
After you’ve done some research and analysis to find stocks that you want to invest in, you can go ahead and use your brokerage account to make those investments.
DIY 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.
DIY 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 in order to achieve that, you’ll need to be adding to your investments on a regular basis. Set a goal that you want to invest each month and put it in your budget like any other expense. Make it a priority to invest this money each month and you’ll see your portfolio grow faster than you expected.
DIY 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 those dividends to cover your expenses. Of course, if you’re able to continue reinvesting even longer, that’s great!
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. Start 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.
2. 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.
3. 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.
Of course, it’s easier said than done, but 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
Starting a blog is a side hustle that many people love, and one that turned into a full-time business for me. Some other excellent options include freelancing, working as a virtual assistant, selling on eBay, and selling on Amazon.
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 in order to have success. This approach is also very effective when it’s combined with another source of income (like social security, a pension, or a side hustle).
Although living off dividends may be your goal, keep in mind that withdrawing money from your portfolio can be just as effective if your portfolio is growing by more than what you are taking out. Dividends can be a great thing, but don’t pursue them blindly at the risk of losing sight of the big picture of your overall portfolio.