Everyone who is looking for a source of passive income would be interested to know the answer to the question: “Is it possible to live on dividends from shares?”. Owning shares brings a good profit if one has enough competencies to compile a portfolio and understand the mechanisms of the dividend strategy. To fully switch to passive income, you need to invest in reliable securities with a good dividend yield and high reliability. Let us analyze how much time and money it will take to start investing in stocks and how to properly manage your investment portfolio.Contents
- Is it possible to achieve a decent standard of living with dividends?
- How much initial capital is required?
- How long will it take to accumulate the required sum?
- Risks of the dividend strategy
Everyone who is looking for a source of passive income would be interested to know the answer to the question, “Is it possible to live on dividends from shares?” Owning shares brings a good profit if one is knowledgeable enough to compile a portfolio and understand the mechanisms of the dividend strategy. To fully switch to passive income, you need to invest in reliable securities with a good dividend yield and high reliability. Let us analyze how much time and money it will take to start investing in stocks and how to properly manage your investment portfolio.
Is it possible to achieve a decent standard of living with dividends?
There are two ways you can earn money on shares: through independent investment and trust management. In the first case, you need to understand the mechanisms of the securities market, constantly monitor trends and stock prices and catch signals to sell or buy shares in time.
In the second case, the investor transfers the right to manage their finances to a professional. In this case, there are also two options: 1) a professional manager buys and sells shares at their own discretion, or 2) the investor gives the investment manager orders and the investment manager will work with a stockbroker to fulfill them.
The dividend strategy assumes that the main goal of the investor in constructing a portfolio is high returns in the form of interest and not on the growth in the value of shares.
Therefore, a thorough evaluation of the potential profitability of securities is essential. A well-balanced portfolio will ensure a stable income with annual growth. If you manage the investment process effectively, you will be able to live comfortably off the income from your investments.
Advantages of the dividend strategy
The investor receives two types of income from owning shares: profit due to the difference in the exchange rate between the purchase and sale of shares and income from interest. The dividend strategy is suitable for those who do not wish to engage in trading but want to invest their money in order to generate a passive source of income.
This strategy has the following advantages:
The ability to predict income. US companies try to pay the same amount of dividends throughout the year. The annual increases in payments are approximately the same every year.
Stable cash flow with a balanced portfolio. American companies mostly pay dividends on a quarterly basis, though some companies pay dividends monthly.
Companies that pay dividends consistently show that their position in the market is stable and that they are willing to share their profits with shareholders. Therefore, the risk of losing the investment is low.
The compound interest effect. The investor increases the portfolio due to reinvestment of dividends, their own funds and growth of interest payments. As a result, the shareholder will earn more and more income from the dividends every year.
A dividend strategy is a long-term investment. By buying shares today, the investor can secure a decent income for themselves in the future.
How much initial capital is required?
You can invest either small or large sums of money in dividends. You can also select an investment strategy based on your financial situation. By selling a business, excess real estate or other assets, you can create a portfolio of stocks to earn a dividend income. For example, an investment of $10,000 will bring in $300 annually with a dividend yield of 3%.
You can start building a portfolio with smaller amounts, such as by buying $100 worth of dividend shares every month (or week). In this case, it will take you more time to generate good interest income.
How much money should one invest in stocks?
If the investor plans to continue working but prepares a cash cushion for the future, they can start with any amount. By purchasing dividend shares for several years and reinvesting the interest received, they will reach a decent passive income after 20-30 years of owning a portfolio.
Let us take an example. Buying $100 worth of stock every month ($1,200 a year) for 30 years will result in an income of $21,000 per year and an accumulation of more than $55,000 in a securities portfolio. Part of the shares for the specified period may considerably increase the yield and the real profit of the investor will be even higher.
Those who want to live on dividends right now need to invest an amount that will ensure the influx of the necessary income. To calculate how much you should invest, take the amount you need to live comfortably (rent cost, food cost, etc.) and multiply it by 12 months. For example, a family spends $1,000 a month or $1,200 a year. The average US stock yield is about 5%. So the initial capital required will be $24,000.
To calculate how much money you need to invest initially, a simple formula can be used:
Investment = Annual Income / Dividend yield x 100 %
In our example described above, it will work out as:
Investment = $1,200 / 5% x 100% = $24,000
Please note that the tax rate and the broker’s commission should be taken into account when calculating the required initial investment or the monthly investment.
How long will it take to accumulate the required sum?
How can you live comfortably off stock dividends? To reach an income of $100 per month, you need to invest $40,000. You can accumulate this amount in about 7 years. To reach this amount, you need to save about $400 every month ($5,000 per year) and have a return on investment of at least 5% per year. You must invest all the resulting profits in the purchase of new shares. In the first year, you will set aside $5,000 and get an income of $250 from interest. In the second year, you will have saved up $10,250 ($5250 from last year plus $5,000 this year) and you will receive a yearly interest income of $763. In 7 years, you will have accumulated $40,710.
Notice the difference. If you save $100 per month, you will need as much as 21 years to get to $40,000.
Please beware that these are very approximate calculations. Many factors might influence the growth of dividend income, such as the size of the company's profit, the increase or decrease in payments on shares, macroeconomic indicators and the state of the economy as a whole.
How can you account for inflation and use an individual investment account to increase savings?
The undoubted advantage of dividend stocks is the automatic accounting of inflation. The interest on the shares is paid out of the company’s profits. Therefore, the change in the level of inflation does not affect them as much as bank deposits or other transactions.
For instance, a company accounts for inflation when raising the final cost of its products as a response to an increase in production costs. Its cash flows grow, it preserves its profit and pays dividends, protecting investors from inflation.
Risks of the dividend strategy
Using a dividend strategy carries considerable risks for the shareholder:
1. The cancellation or reduction of dividend payments
This risk can be offset by the correct balance of securities in the portfolio: shares of companies from different industries, regions, and countries.
2. The bankruptcy of the company
It is difficult to make predictions about the future, but your investment can be protected if a company declares bankruptcy. If you have many different companies in your portfolio, their dividends can cover the loss from the bankruptcy of one company.
For instance, there are 15 different companies in the investor's portfolio, each of which accounts for 6.7% of the portfolio. If one of the companies goes bankrupt, the dividends of the other 14 will prevent the investor from going broke, but you will receive less than the expected profit. If there are shares of only one company in the investor’s assets, the shareholder will lose not only their monthly income from the dividends, but also all of their investments if that company becomes bankrupt.
Holding dividend shares allows you to live on the profit from them alone if you start investing 15-20 years before giving up other sources of income, such as wages, profits from your own business and rental income.
To ensure a comfortable standard of living, the minimum investment will be $400,000 - $500,000. You can reach this amount without initial capital in 15-20 years if you form a portfolio of dividend shares from all of your sources of income and reinvest the profits earned.
To minimize the risk of losing your investments or reducing profitability, you need to know how to build a good portfolio. You should evaluate the financial stability of companies, analyze their payment data in previous years and choose shares with a yield close to the market average. Experienced investors give a positive answer to the question, "Is it possible to live well on dividends?" But to do this, you need to either invest a lot of money at the start or form a long-term strategy if you have no initial capital.