One of the key ways to stretch your investments in retirement is to live solely off of dividend income. Dividends offer a way to get monthly income without having to sell your investments.
In this guide, we’ll explain how to live off dividends and what you need to consider when investing in dividend stocks for passive income.
What is a Dividend?
A dividend is a payment that companies make to their shareholders as a reward for holding the company’s stock. Dividends are typically paid out in cash, although they can also come in the form of additional stock.
The amount and frequency of a dividend is determined by a company’s board, and dividend payments can vary based on how profitable the company is. However, most dividend-paying companies work hard to keep their dividend consistent and gradually increase payments over time.
When comparing dividend stocks, there are two key factors to consider:
The dividend yield is the percentage that a company pays out in dividends relative to its share price. Since the yield normalizes a stock’s dividend to its share price, you can use yield to compare the size of dividends between companies.
The dividend frequency is how often a company pays out a dividend. Most dividend-paying companies make payments quarterly, but some make monthly, semi-annual, or annual payments.
How to Live Off Dividends
In order to live off dividends or retire off dividends, you need to consider your total financial picture and then figure out what dividend stocks to invest in. We’ll break the process down into 5 steps.
Step 1: Determine How Much Income You Need
The first step in figuring out how to live off dividends is calculating how much money you need to live. Look at your monthly expenses to get a sense of how much you spend in an average month. Remember to subtract any expenses that you plan to eliminate in retirement and to leave room for unexpected expenditures.
Step 2: Determine Your Risk Tolerance
When comparing dividend stocks, it’s important to remember that not all stocks carry the same level of risk. Stocks that tend to pay out high dividend yields – 5% or more – are risky in the sense that these stocks often can’t sustain their dividends indefinitely. The dividend might be cut or canceled altogether with little warning.
Alternatively, some stocks that pay out high dividend yields have very volatile stock prices. You might receive a nice dividend, but that can be offset if the value of the shares you’re holding drops significantly.
It’s up to you to decide whether you’re willing to accept higher financial risk in exchange for potentially larger payouts. If you want to invest in lower-risk dividend stocks, be sure to look at companies’ history of dividend payments. The safest dividend stocks are those that have a long history of paying dividends on time and that consistently increase their payouts to shareholders.
Step 3: Determine Your Preferred Payout Schedule
An important thing to consider when assembling a dividend stock portfolio is when each company pays out dividends. Most dividend stocks offer quarterly dividend payments, but some offer monthly or annual payments.
This is important because your income will vary throughout the year based on when your dividend stocks pay out. If you choose stocks that make monthly dividend payments, you can get relatively consistent income throughout the year. On the other hand, if you have several stocks that pay out quarterly or semi-annually, you may have high dividend income in some months and little to no dividend income in other months.
Step 4: Choose Your Dividend Stocks
With all of these considerations in mind, it’s time to pick your dividend stocks. It’s a good idea to invest in at least several different stocks and as many as 20-30. That way, you can choose a variety of stocks with different yields, risk profiles, and payout schedules. Look for stocks in different industries, too, so that your dividend income isn’t overly affected if a particular market sector falls on hard times.
Step 5: Invest
Once you have the stocks to add to your portfolio picked out, it’s time to invest. Be sure to use a broker that doesn’t charge ongoing account fees, since these can eat into your dividend income. Also, make sure that you opt not to reinvest dividends. Otherwise, your dividend payments will be automatically reinvested to buy more stock in your portfolio rather than delivered to you as cash.
Considerations for Picking Dividend Stocks
There are several things to consider when choosing dividend stocks.
First, pay attention to dividend growth or decline over time. Financially strong companies typically grow their dividends and aim to keep their dividend yield consistent as the share price grows. Companies that are struggling will often cut their dividend to conserve cash. Watch out for companies with a history of dividend decline, as this signifies that the dividend could be suspended altogether in the future.
It’s worth looking at whether a company has always paid out dividends on time, or whether it has suspended or delayed dividends in the past. Companies that have decades of on-time payments are more likely to want to protect that legacy even in hard times, which is a good thing if you’re relying on dividend payouts for income.
You should also watch for volatility in the price of a dividend stock. Changes in the share price not only affect your dividend yield, but also the value of your investment. Even if a stock pays dividends on time for as long as you own it, you can still lose money on your investment overall if the stock price drops significantly.
Finally, be sure to give yourself some wiggle room when calculating the amount you need to live. Unexpected expenses happen, and you can limit your ability to live off dividends if you have to sell stock to deal with these costs. Along the same lines, dividend cuts and suspensions do occasionally happen. You should have enough room in your budget to absorb a dividend cut, at least temporarily.
Conclusion: Living Off Dividends
Dividends offer a way to cover all your expenses without having to sell stock or generate other income. That way, you can stretch your retirement or even boost your wealth. When putting together a dividend portfolio, be sure to include stocks with a variety of yields, risk levels, and payout schedules.