Living off dividends in retirement – The passive income dream

Earning enough passive income to pay all of your expenses forever is the dream of any investor. One way to do that is to earn passive income through dividends. As I approach my own financial goals I begin to wonder to myself what is realistic.

Can you live off dividends in retirement?

You can absolutely live off dividends in retirement. Simply build a portfolio of dividend paying stocks large enough that the total annual dividend payments will cover your total annual expense.

Sounds simple enough. So how do we accomplish it? Lets start at the beginning.

What is a Dividend?

When you buy a stock you become a shareholder of that company. Companies reward their shareholders in one of 2 ways.

• Grow the business thus increasing the price of the stock and the value of the shareholders
• Pay a dividend to shareholders.

A dividend is simply a company paying out a portion of its profit to shareholder. Companies pay dividends either quarterly or monthly and are announced on a per share basis. For example, a company may announce that they will pay a quarterly dividend of $.50 cents per share every quarter. So if you own 100 shares, you would be paid $50 in dividends.

When a company declares a dividend,(the declaration date) they will also announce the ex dividend date. The Ex dividend date is the date you must own the stock in order to be eligible for the dividend. If you purchase a stock after their ex dividend date, you do not get paid the dividend.

Finally, the payable date is the date the dividend will be paid to the share holders.

What is dividend yield and why is it important?

Dividend yield is the dividend a company pays expressed as a percentage of the current share price. So if a company with a share price of $100 per share pays a quarterly dividend of $.50 cents or $2.00 per year, the yield would be 2%.

Yield is an important measurement to investors looking to capitalize on dividends as a form of steady cash flow. Yield also helps you to measure your annual growth. Some investors will buy dividend stocks with the intention of never selling regardless of the stock price. They are happy with the yield itself as the annual growth rate. For example, if I own a portfolio of stocks that yield a combined 5% in dividends, I will earn at least 5% for the year. If I never sell the stocks I never lose money even if the proce goes down. One problem with this technique is that companies whose stock price drops, usually also lower their dividends. We will discuss this more later when we touch on investment strategies.

Yield on cost

Yield on cost is of particular interest for long term investors who intend to allow their dividends to re-invest and grow over time. We can define Yield on cost as basically what the current dividend represented as a percentage of your original cost for those shares. For example, a stock currently pays a dividend of $2 per year and the current price is $100. The current yield is 2%. However, if you purchases that stock a few years ago when it was only $50 per share your yield on cost is 4%

Yield on cost is really just another way to measure the success of an investment. You would expect the stock price as well as the dividend paid to go up over time. Conversely, this will increase your yield on cost.

Dividend Reinvestment Program (DRIP)

A Dividend Reinvestment Program (DRIP) is a plan offered by companies that allows you to automatically reinvest your dividend payments into additional shares or fractional shares of a company in lieu of cash payments. This can be an extremely valuable tool for long term investors whose goal it is to maximize the compounding effect this has over time. DRIPS also allow for the purchase of fractional shares in the event the dividend payment does not cover the total cost of a share. It is important to note that dividends reinvested through a DRIP program still qualify as taxable income and will need to be reported as such.

Building a Dividend Portfolio for Retirement

Once you understand the power of dividend income and compounding, you can begin to devise an investment strategy. The goal of an investor planning to retire using dividend stocks is to earn enough income from dividends to pay their annual expenses. The dividend investor in this case does not care about the value of the stock or its growth rate. They are only concerned with the question, “Will the dividend payments cover my expenses in retirement?” The shares of stock themselves act as a safety net, but the intent is to never sell them but instead live off the dividend payments forever.

if you think you just don’t have the money to invest now, then you need to check out my article on why you are broke and what to do to change it.

If that doesn’t do it for you, here are 10 insanely easy tips for cutting spending to help you start saving towards your dreams of becoming rich.

As with most areas of investing, everyone has their own opinion on the best way to build a long lasting, cash dispensing dividend portfolio. Here are four strategies I have used to varying levels of success.

#1 Individual Stocks

The first strategy for building a dividend portfolio is to pick individual dividend paying stocks. This will require you to have the time to really dig in and study the balance sheets of a good number of companies so you know what you are getting in to. There is a certain level of risk that goes in to investing in any company, and the more well informed you are, the better decision you can make, the lower your risk.

It takes a lot of research to become informed enough to feel comfortable picking stocks. One example from my own experience where I failed to do enough research is Kraft Heinz (KHC). I jumped on board far to quickly as the price sank. I figured, even if the stock continues to fall at least I will collect a healthy dividend. As the price of the stock continued to slide in 2018 and early 2019 its yield climbed to over 5%.

Then, In February 2019, quarterly results were poor and they decided to cut the dividend from 62.5 cents per share to 40 cents per share. Many investors were not happy with this and dumped the stock causing The stock price to plummet 20% in a day. By the time the dust had settled I was down over 50% on the position and my dividend had been cut 36%. The moral of the story, you need to do your research and don’t put all your eggs in one basket. Which leads us to strategy #2.

#2. Diversify with Index Funds

Index funds are investments that bundle individual stocks together for you. They have done the research and have grouped these stocks together into one fund so you have a diversified fund. The stocks can be grouped in many different ways from sector, to S&P 500 stocks, to all dividend paying stocks.

You can find many index funds that are well diversified and pay healthy dividends. By investing in these funds you retain the benefit of the dividend paying stocks while reducing the risk involved in picking individual stocks on your own. You also reduce the time required to research and re-balance your investments each year.

Dogs of the DOW

The Dogs of the Dow is an investment strategy where investors purchase shares of the 10 Dow Jones Industrial Average stocks with the highest dividend yield.

The thought process behind this strategy is that these blue chip companies will always be safe investments. While their dividend remains steady due to their solid core business practices, market fluctuations may cause the price to drop temporarily. As a result, this has an inverse effect on the dividend yield which has caused the high yield. This means that these companies are likely to experience price increases in the future as fluctuations in the market cause prices to move upward.

A popular variant on this strategy is the small dogs of the Dow. These are the 5 Dow Jones companies with the highest dividend yield.

As with any stock market investments, there have been years where the dogs and the small dogs have been out performed by the dow.

Here is a list of the 2019 dogs of the dow.

Dividend Aristocrats

Dividend aristocrats are those companies who have increased their dividend payouts for a consecutive 25 years or more. These are large cap, blue chip companies from a variety of sectors. Dividend aristocrats are attractive to investors not only for their dividend but their long history of steady growth.

Any business capable of increasing a dividend for 25 years must have a durable business and offer investors confidence that this must be a safe investment.

The dividend aristocrats have typically outperformed the S&P 500. Over the last 10 years the aristocrats have an average return of 12.5% annually vs 8.5% for the S&P 500. Also, these stocks typically outperform the rest of the market during down turns offering yet another measure of safety for investors.

Here is a list of all 57 companies that qualify as dividend aristocrats arranged in order from longest years of increased dividends.

Dover (DOV) – 63

Emerson Electric (EMR) – 62

Genuine Parts (GPC) – 62

Procter & Gamble (PG) – 62

3M (MMM) – 60

Cincinnati Fin. (CINF) – 58

Coca-Cola (KO) – 56

Johnson &Johnson (JNJ) – 56

Lowe’s Companies (LOW) – 56

Colgate-Palmolive (CL) – 55

Hormel Foods (HRL) – 53

Federal Realty Inv. Trust – 51

Stanley Black & Decker (SWK) – 51

Sysco (SYY) – 49

Target (TGT) – 47

Becton Dickinson (BDX) – 47

Leggett & Platt (LEG) – 47

PPG Industries (PPG) – 47

W.W. Grainger (GWW) – 47

Kimberly-Clark (KMB) – 46

Nucor (NUE) – 46

PepsiCo (PEP) – 46

VF (VFC) – 46

AbbVie (ABBV) – 46

Abbott Laboratories (ABT) – 46

S&P Global Inc. (SPGI) – 45

Wal-Mart Stores (WMT) – 45

Automatic Data (ADP) – 44

Consolidated Edison (ED) – 44

Illinois Tool Works (ITW) – 44

Archer-Daniels Midland (ADM) – 43

Walgreens Boots (WBA) – 43

McDonald’s (MCD) – 43

Pentair (PNR) – 42

Clorox (CLX) – 41

Medtronic (MDT) – 41

Sherwin-Williams (SHW) – 40

Franklin Resources (BEN) – 39

Aflac (AFL) – 36

Air Products & Chemicals – 36

Cintas (CTAS) – 36

Exxon Mobil (XOM) – 36

AT&T (T) – 35

Brown-Forman (BF.B) – 35

McCormick & Co. (MKC) – 33

Cardinal Health (CAH) – 32

T. Rowe Price (TROW) – 32

Chevron (CVX) – 31

Ecolab (ECL) – 27

General Dynamics (GD) – 27

People’s United Financial (PBCT) – 26

Roper Technologies Inc. (ROP) – 26

A.O. Smith (AOS) – 25

Caterpillar Inc. (CAT) – 25

Chubb Ltd (CB) – 25

Linde PLC (LIN) – 25

Dividend payments create a compounding effect the same as stock growth or paid interest. If you don’t understand compounding, or just want to learn more, check out this article I wrote on the power of compound interest.

If you still aren’t sure where to go from here, I have two articles to help you.

First is an article I wrote outlining the pros and cons of investing in the stock market which you can check out by clicking this link.

Still not sure, perhaps its time to hire a wealth management professional. Check out my article on financial advisors here.

Good Luck

Earl