Just as retiring comfortably means different things to different people, it also presents almost unlimited financial scenarios: taking out a reverse mortgage, selling off possessions, moving to a place where the cost of living is cheap. (If you’re counting on Powerball, well, good luck with that.) Add to that list a sometimes overlooked option: living on investment dividends.
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The question is, can it really be done if you’re not in the top tier of wealthy people?
To be sure, the debate over “how much money is enough” is endless and broad.
And so much depends on the kind of life you plan to lead in retirement. However, there are a few guidelines that can help you zero in on the perfect savings balance for you. Consider taking these three steps as you take an active stab at passive income.
Step 1: Define what wealth means to you
There’s no perfect number, right? A person who’s paid off their modest mortgage and grows their own veggies in a small town may feel far more at ease than the city dweller who still has a raft of high monthly expenses that forgot to read the retirement memo.
With your desired lifestyle, thinking about whether passive dividends will do the trick is indeed all about the numbers. Major banks and institutions like Knight Frank use seven digits to define their ideal customers.
According to its 2022 Wealth Report, a person with $1 million in investable assets qualifies as high-net worth, while someone with $30 million or more is considered ultra-high net worth.
What’s more, if you earn more than $570,000 a year or have more than $11.1 million in assets you’re “richer” than 99% of Americans. But that’s where “location, location, location” comes in. A million dollars in Midtown Manhattan isn’t the same as a million in Mumbai.
Why does this matter? If you consider wealth relative, you’ll want to generate more money in passive income, or just enough, compared to others in your age group. It depends on your geographic region or other variables — a major one being whether your home is paid off.
If you consider wealth absolute, then hit the Excel sheet or QuickBooks program to nail down how much you’ll spend — both fixed and flexible expenses — versus your pre-retirement earnings.
Whatever the difference will be once you start living off savings and Social Security is your magic number to solving the dividend equation.
Step #2. Calculate your rate of return
Let’s assume you’ve arrived at a target of $100,000 in annual income. With forecasting how much dividend income you can safely expect, historical numbers provide a reliable barometer.
The S&P 500 offers a current dividend yield of 1.6% and has delivered an average of 2.34%. That means if you want to generate $100,000 in annual passive income from a vanilla index fund, you would need $4,273,504 in assets ($100,000 divided by 2.34%).
Close the gap with whatever retirement income you already have and if the number is lower than that $100,000 — say, just $10,000 — you’ll be in better shape to experience dividend-derived freedom. To hit the $10,000 mark, you’d need roughly $427,000 at a 2.34% return.
You could extract a higher return from a dividend-focused fund like the Vanguard High Dividend Yield ETF (NYSEARCA:VYM). Since 2018, the fund’s median dividend yield has been 2.97%. That means you’d need just $3,367,003 to generate $100,000 in passive income annually.
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Step #3. Name your margin of safety
Remember those surprise bills that came in your working years? Well, they’re not about to stop now. But if you use a strategy based on what’s called the safe retirement rate, you can forecast how much money will get you through 30 years. According to Morningstar, that’s 3.8% of your retirement portfolio annually.
That assumes a 50-50 split of stocks and bonds, and how many of those stocks award dividends. As you can see, it often gets complicated, because how much your stock appreciates in value and how much you get in dividends are not the same thing.
What’s more, dividend stocks could underperform in the years ahead, and inflation will make it more expensive to retire in 2033 versus 2023; Morningstar predicts a long-term annual inflation rate of 2.8%.
That’s why it’s smart to seek out a financial adviser with all your financial questions, including the Great Dividend Question.
Putting it all together: Simple is a smart starting point
Otherwise intelligent people find the task of pulling together their numbers so overwhelming that they make the baffling choice of leaving retirement to chance.
But what might’ve worked in an adventurous youth doesn’t square with the wisdom and prudence that comes with old age.
Starting simple will bring your retirement lens into focus as you discover your unique vision of wealth and financial freedom, the twin pillars of a sound investment strategy.
No matter your worries or challenges, start from where you are. Don’t leave things up in the air — and if you want to ignore the numbers, Powerball has plenty worth skipping.
Need help? Call in an expert
Setting yourself up for a comfortable retirement is nerve-racking — especially with still-hot inflation and a long-discussed recession apparently just peeking around the corner.
One tip to help you sleep better: Find a professional who can help navigate your finances and help you safeguard your assets.
The act of finding a financial adviser — researching, calling around and asking for references — can be time-consuming hassle. But now, it's as easy as curling up on the couch and browsing through an offering of vetted advisers. From there, booking a consultation is free and only takes a few minutes.
If you're unsure how to protect your financial future during a recession, it’s better to find answers sooner than later, while time is still on your side.
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
