I’m about to condense some of the most valuable knowledge that I’ve been taught over the last few years into a couple of sentences. Ready?
If you want to be truly free in this world, you need to master your money.
You need to transition from an employee who works for active income to an investor who sits back and earns passive income.
We all start having to work for money but, the more you save, the closer you can get to the goal of financial independence, where all your expenses are covered by your passive income streams.
That doesn’t sound too bad, does it?! 😉
The Single Best Source of Passive Income
There are many ways to make passive income. A couple of weeks ago I shared 11 passive income ideas to help you start earning money without having to work for it directly.
You may have noticed that I am pretty biased towards what I consider to be the best source of passive income there is: Dividend Growth Investing.
This is how it works:
When a company grows enough and starts trading publicly (when it has shares in the stock market) it can choose to start paying dividends to its shareholders. Not all companies do this, as it is often better for them to reinvest all their profits back into the business to keep growing.
However, companies get to the point where they start to experience diminishing returns from their internal investment, so they start paying their shareholders to keep them happy. If you run a global business that sells deodorant to the entire planet, it can be challenging to reach an even larger market!
Becoming a Shareholder is Awesome
Let’s say you’ve decided to listen to reason and start saving some money every month and investing it into carefully picked stocks.
You’ve opened an account with a broker and transferred this month’s savings into it. You then research a few companies that are attractively valued at the moment and go for Coca-Cola.
If you’ve never heard of this company, they make fizzy drinks that a few people drink here and there. 😉
What you may not know is that for the last 54 years, The Coca-Cola Company has not only been paying dividends consistently – it has been increasing them.
Every. Single. Year.
In that time, the share price has done something like this:
This is the best part; even through the lowest drops – including wars and recessions – it has increased its dividend payout to the tune of 8%.
Can you imagine your employer giving you an 8% pay rise every year? Your salary would double every 9 years (according to the handy rule of 72).
Coca-Cola is only one example of a Dividend Champion – a company that has been raising dividends non-stop for more than 25 years. There are literally hundreds of companies with a solid dividend history, which you can see in David Fish’s amazing spreadsheet.
You see, when you’re a shareholder, you enjoy the rise in stock prices and the consistent dividends. It’s pretty sweet.
If you look at historical data, it’s easy to see just how sweet it is. The graph below was created using Robert Shiller’s data and plotted by Reddit user u/zonination – here’s the full write-up. This is historical data from the S&P 500 going back 145 years.
If you invested 1 dollar in various stocks and reinvested all dividends that you received, you’d double your money every 10 years. This also takes into account yearly inflation, so you can’t use the excuse that “money now isn’t worth as much as it was“. 😉
You may be wondering why the average person doesn’t invest in dividend-paying stocks and keep reinvesting their dividends for decades. The answer is simple: fear.
I’ve written before about fear and investing, and how there’s only one intelligent thing to do when the stock market tumbles. However, most people panic when they see their stock drop in value over a short period of time.
While I wasn’t in the market during the last recession, I’ve seen some minor but heavy drops in the market. It’s not a nice feeling to see your portfolio drop 12% in one day, but dividends make it much easier.
Businesses repay your trust in them with dividends. It’s great to see that, no matter how low the value of your stocks drops, you’ll still be paid the same amount of dividends – and probably more.
It’s not just speculation – it’s real, tangible money. It’s entirely possible to retire and live off dividends for the rest of your life without even touching the principle – i.e. never selling a stock.
Famous Investors
Dividend growth investing isn’t sexy. “Slow and consistent wealth” isn’t as appealing as “get rich TOMORROW!!!”.
This could be the reason why you don’t hear many famous people announcing their dividend strategy. However, there are two people who are prolific dividend investors:
Warren Buffet’s Berkshire Hathaway owns famous dividend growth stocks such as Coca-Cola, IBM and Procter & Gamble – and by that, I mean that he owns really big chunks of each of these companies.
Bill Gates, who played a big part in me being able to work from home using a computer (thanks, Bill!) also owns several long-running dividend-paying companies such as Wal-Mart and Caterpillar.
Another not-so-famous dividend investor went by the name of Ronald Read. He worked as a janitor and only made a modest income, but he managed to save a lot of it through frugality.
Through investments in quality, blue-chip companies such as AT&T, Bank of America, CVS, Deere, GM and General Motors, his portfolio rose to a staggering $8 million.
If he could do it, what’s your excuse? 😉
How to Live off Dividends – Step by Step
So, are you ready to start building the portfolio that will allow you to retire early – or at least never have to work for money again?
These are the steps you need to take:
- Open a brokerage account.
- Link your new brokerage account to an existing bank account and withdraw some money.
- Learn how to do some basic analysis on dividend stocks – this is a great starting guide.
- Buy stocks when their valuations meet your criteria.
- Reinvest any dividends that you receive into buying more stocks.
- Repeat until the amount you earn in dividends can cover your expenses.
- Enjoy being the master of your time!
If you want to see how far your money could go if you invested in dividend stocks, I’ve created a handy calculator for you!
OK, I actually made it for myself so that I could calculate when I’ll become financially independent, but I’m more than happy to share it.
You can download it for free below:
Living off dividends without having to ever work again is a real possibility for anyone. As long as you can earn money, save a decent part of it and keep reinvesting the dividends that you earn passively, you’ll become financially independent.
Well-written and interesting introduction to investing, and dividends in particular. Do you follow a dividend stock strategy yourself? And, if you do, have you been able to build a meaningful passive income stream from it?
Yeah, I’ve been doing it for two years now. I’m currently averaging around a 4.1% yield – which doesn’t include the actual rise in stock prices. That’s a nice amount of money every month, which covers some of my bills 🙂
I’m still very far from covering all my living expenses, but I’ll get there in a few years. Dividend growth investing will probably still be my main income source in retirement.
Easy to read article, but with a wealth of knowledge! I’d be interested to know as I’m a new reader do you already do this yourself or is this a goal you are shooting for?
Hey Barnabas,
I’ve been doing it for two years now, and it’s been great. It’s hard to see your net worth drop every now and then, but I’ve definitely experienced a significant profit.
Thanks for reading – hope you stick around! 🙂
Great overview. I once heard dividend income as “eating apples off the tree” instead of chopping a small piece off the apple tree (income from the sale of stock). I’d love to eventually get to the point where I’m using the combined tactic of dividend stock and index fund investing. Thanks for the renewed energy for learning more about dividend stocks!
A jacked-up qualified dividend income plan would include staying in a 10%-15% tax bracket and not pay taxes on any of it.
It will take a long time to create a six figure portfolio unless you have a really good paying job, no kids etc, etc. Andcwhen you say 6 figures there a big difference between $150k earning dividends and $900k.
If you have $900k saved(who has that?) and you get a 4% return which is pretty good, you still only will make $36,000 per year. Before tax. That’s tough to live on if you have a mortgage etc. You will need at least 1.5 mil to replace a $50k/year salary.
You’re right, you do need a lot of money to earn significant dividend income, but it’s not money that you have to earn outright. Investing compounds your money every year – it usually doubles every 10 years, according to historical data. So if you saved about $225k and left it for 20 years, you’d get a portfolio worth $900k.
It’s also all relative to how much you need to live vs. how much you can earn. Some people will thrive on very little and still be able to save 50% of their income, while others prefer a more luxurious life.
But if you are willing to save aggressively, live well below your means and invest wisely, you will be able to become financially independent in a couple of decades.
Richard, It definitely can be done. 20 years is really not that long. I started saving in my early 30’s via funding a 401k. That is the year when the company I worked for began offering 401K’s and the sales pitch from the investment guy was exciting. I bit into it full tilt, oh those fees I paid. By the time I was early 40’s I decided to back down the 401K to fund a ROTH and a brokerage account. In my mid- 40’s I began seeking dividend income, and I reallocated my brokerage account and my ROTH for this. I also funded a ROTH for my wife. At 48 I entirely stopped contributions to my 401K and left my crappy job for a lower paying position that was more fun, because I felt comfortable with the pay cut and I was tired of what I was doing. By 50, I hit 7 digits in my accounts. I also added a second ROTH for my wife. At 52, I rolled my old 401K into a self directed IRA allocated to dividend income. Currently at 54 with 1.7m in the accounts, 1.2m of it is dedicated to dividend income and generates $74k/yr. $500k is still in mutual funds via my wife’s various 401k’s. A substantial amount of the dividend income is tax free (ROTH) or deferred (IRA) or in qualified dividend stocks (regular brokerage account). All of this income is reinvested. Wife and I both still work. You must have made high salary? Not really. Our highest annual combined salary was slightly over 100k, we were not what you would term “highly paid” but comfortable. Today we could retire if we desired. 72T withdrawals plus convert the remain 500k to dividend income and we would have a net income higher than our best salaried year of employment. I assume most folks reading your column have interest if it is really possible. Yes, it is; I’ve done it. Good luck to all.
Don’t know if you will see this but what stocks did you invest in? I’m young so I’m not sure if I should go for growth or value stocks. But it seems like value stocks would pay off in the end as they will pay dividends.
Even if you don’t make enough money to completely replace your income, you can still pursue a strategy that helps supplement your income in retirement years. That’s the approach I’m taking although I’m still working towards completely replacing my income. I also agree that DGI is one of the best ways to make passive income.
What is your opinion on cryptocurrency? I think that everyone should invest about 10% of their funds into 20-30 altcoins (anything except for Bitcoin) and a bit on buying Bitcoin. I think the prices will go up for most of them but you do need to wait a bit (2-3 years) to get a good ROI.
Nice article!
DGI is clearly a strategy I’ve also adopted to cash flow my early retirement. It’s certainly not fast, but it is relatively low risk and the returns aren’t bad either. Like anything, staying on course for 10 – 20 years is the hard part. Looks like you are doing a great job!
Great article.
It actually doesn’t even take that long to grow the annual dividends brewing generated from the portfolio.
I started dividend growth investing in mid 2014, earning $17K in dividends. I went all in in 2015, moving from mutual funds and bonds into a basket of individual dividend paying and dividend growing stocks, income that year was $56k USD. In late 2015 I suffered several dividend cuts in mid energy pipeline companies and in the mining sector. I kept putting in fresh capital and 2016 dividend income was at $60k.
2017 saw no cuts and many raises plus reinvesting dividends and adding fresh cash and that year brought $75k in dividends. This year GE cut their dividend in half but it was offset by multiple companies raising and fresh cash from selling a few companies that became richly valued and adding yet more fresh cash, an on track to generate more than $90k in dividends this year. Next year should be north of $100k and it only goes up from there…
This money is in after tax accounts and I’m 45 years old. I continue to work but could effectively live off these dividends. It’s a wonderful feeling, like discovering a cheat key to the video game of life.
I hope you all experience this feeling soon and best wishes.
-Mike
Hey Mike H,
Your comment is music to my ears. Love hearing your dividend investment strategy working year over year, and making some serious passive income. How much investment capital did you have invested to hit that $50-60k/yr in dividend returns?
Great read!!! I can only hope one day my dividends make me some real money to live off .
Excellent article. I too am a fan of stock dividend investing. I am at retirement age now, but if I were younger I would open a ROTH IRA and then purchase dividend stocks (or mutual funds or ETFs that buy high-quality dividend-paying stocks) inside the ROTH account. With this strategy, your investment can compound year after year tax free, and when the time comes to start living off those dividends, you can make tax-free withdrawals. I know this means you can’t touch the money until you are at least 60, but realistically very few people will be able to retire younger than that age anyway.
Please just cut the chase and get to the point!
Which stocks should i buy to cover a 12 month of income..
Be the first to tell!
All shitblogs write “these stocks” and then just yada yada pladder pladder…. Just. Give. Us. The. Stocks.
What a lovely comment 😉
It’s more complicated than just telling you which stocks to buy…
First, what do you need? How much income do you need to cover 12 months? Assuming a starting yield of 4%, just multiply that by 25 and that’ll be how much you need.
That’s the short version, of course. You can get there with modest amounts over a longer time period, which is what myself and a lot of people are doing.
Now onto choosing stocks. It takes training and a proven system. I could just tell you which ones to buy, but what good would that do if you don’t understand the reasoning behind it? What if the stocks I tell you drop by 30%? Would you know what to do then? Or would you just sell everything in fear, like most people do?
Psychology is extremely important when investing. It’s what separates a successful investor who will succeed from someone who will buy a few stocks and sell as soon as they are making a profit… My advice would be to sign up to my emails, where I teach you what to do in more detail – and then decide if you want to continue learning the strategy that I teach.
Anyway, if you ever read this reply, I do hope you are happier now 🙂
if you google it like I did you get stocks like AT&T, GM, coke, walmart , exxon/mobile and several others, me i buy 2-3 energy stocks, local electric and duke power, then 2-3 tech stocks, 2-3 industrials…… just google highest paying dividend stocks and choose…. I bought some apple and tesla plus one or two other others that I took as a simple leap of faith…. everything paid but GE, they were on their way down…I’ll be back in the market full time as soon as my wife’s inheritance clears probate…. happy days ahead
Great article. What would you consider to be a minimum monthly amount to invest .
Hey Fidelis – thanks for your kind words 🙂 There is no minimum amount. However, I’d recommend that, at the very least, you save and invest 10-15% of your income. The more the better, really.
What amazes me is the notion that 4% is the dividend yield to bank on. I don’t buy anything under 8% and many in my portfolio are well over 10% yield. Word of investing advice: The wealthy only care about their own wealth. Don’t expect them to teach you how they got wealthy. The only person who cares about your money is you so you.
Hey Nate,
Those sound like classic yield traps. If your starting dividend yield (not your yield on cost) is that high, I seriously doubt the companies are going to be able to maintain them, let alone grow them!
The real power comes from a decent starting yield with decent dividend growth – THAT’S how you take real advantage of compound interest!
Best comment I have read
Is it to late to start this at 50?