One of my favorite books on investing is “The Snowball: Warren Buffett and the Business of Life” by Alice Schroeder. The book describes how Warren Buffett accumulated his fortune starting at a young age, up until early 2008 when he became one of the richest people on earth.
I like the concept of a snowball, where you start small, accumulate snowflakes as you start pushing it down the hill, and then you keep rolling the snowball until it turns huge. After that, the snowball grows even larger, without any additional input from you.
With dividend investing, you start small, and immediately get hooked the moment you receive the first dividend paycheck. The realization that you earned passive income without even lifting a finger has had a huge impact on the dividend investing community. The second realization that if you manage to put more money to work, and if you reinvest those dividends, you are going to grow that passive dividend income in the future. Let’s assume that I earn $20/hour from my job. The way I think about it is that for each $20 in dividend income I can receive today, I am essentially buying an hour of freedom from work. The following story from The Snowball, about Charlie Munger ( Warren Buffett's investing partner at Berkshire Hathaway) really resonated with me:
Charlie, as a very young lawyer, was probably getting $20 an hour. He thought to himself, ‘Who’s my most valuable client?’ And he decided it was himself. So he decided to sell himself an hour each day. He did it early in the morning, working on these construction projects and real estate deals. Everybody should do this, be the client, and then work for other people, too, and sell yourself an hour a day.
Once those dividends exceed the level of expenses by a nice margin of safety at the dividend crossover point, you are financially independent.
Last month, I wrote two articles about my financial position. In the first one, I discussed how much I spend per month. In the second, I discussed how much dividend income I am generating. I received a lot of comments, so I will try to address some of them today.
In today's article, I am going to put things in perspective a little bit. I am going to discuss the future of this dividend portfolio of mine. Please stay along.
One of the comments I received was that $1,500 - $2,000 today might be sufficient today, but might be totally inadequate for me in the future.
The problem with these comments is that they only focused on the expense side, but not the income side. Assuming that I can earn $1,500 - $2,000 in monthly dividend income around 2018, then that would mean that I would be Financially Independent (FI) around that time. I would have become FI in approximately 10 – 11 years of meticulous saving and investing. Easy peezy.
The other problem is that the comment assumes that a frugal person like myself, who has the discipline to always spend less than what they earn, would just go ahead and start spending like crazy. I believe that no matter what curve-balls life throws me in the next decades, my frugal attitude would be helpful in containing costs.
Just because I will be FI around late 2018 however, doesn’t mean that I will simply go off and retire to a beach. After all, for someone who achieves FI in their early 30s, chances are that they will get really bored if they had no challenges to conquer. If I decide to do something productive with my time after FI, chances are that I will earn some income from this activity. Because of my frugal habits, I can live really well on $1,500 - $2,000/month. I can keep working, or I can focus more on blogging, or I can simply find another thing that may bring income – write a book for example. Even if I decide to work a seasonal job where I provide tax or accounting services, I will be able to cover expenses and let dividend income grow.
The nice thing to remember however is the fact that this dividend machine that is producing $18,000 - $24,000 in annual dividend income will grow that dividend income over time. But before looking too much about 2018, let’s think about the expected dividend income I shared for year 2016.
I expect to generate $15,000 in annual dividend income next year. This estimate doesn’t take into account any new capital I will add to my portfolio. This estimate also doesn’t take into account any dividend increase announcements from the companies I hold in my portfolio.
Assuming a very conservative growth of 3% - 4%/year, as well as average dividend reinvestment yield of 3%- 4%, I could reasonably expect to double my dividend income every nine to ten years from here. This would mean that if I never touch my dividend income today (but also that I will never add a single cent of fresh capital to my portfolio), I will expect to generate:
$30,000 in annual dividend income in 2024
$60,000 in annual dividend income in 2033
$120,000 in annual dividend income in 2042
This assumes no money is ever added to this portfolio, and it also includes pretty conservative projections on dividend growth and dividend yield reinvestment. The snowball effect of compounding and reinvesting dividend income is truly evident once you accumulate the first $1,000 in monthly dividend income. When you generate more than $12,000 in annual dividend income, even modest rates of dividend reinvestment and dividend growth can result in $1,000 in additional annual dividend income coming your way without any new capital. The point at which money earns money for you without any additional capital input is when the dividend snowball truly starts to gain traction on its way to achieving its full potential.
These projections were one of the reasons why I am putting as much money as I legally can in any type of tax-deferred account I am eligible for today – including 401 (k), Roth IRA, SEP IRA, H S A etc. I found out that I may end up generating too much dividend income, which may end up being taxed heavily. Plus, if I ever end up earning a lot of money on the side ( maybe DGI blog becomes so mainstream that I end up earning too much from it) I will be just paying taxes through the nose in that case.
So to summarize, I expect to generate enough dividend income that will cover expenses by 2018. Those projections already account for a nice margin of safety in dividend income. Most of the excess dividend income from that margin of safety buffer will be coming from tax-deferred accounts ( and hopefully won't be touched for decades if ever). I do expect to continue earning money at some capacity too however, since I like to stay active and to keep an open mind about learning new skills. Either way, I project that my dividend income will double to $30,000/year by 2024. After that, I expect that my dividend income will keep doubling every nine or ten years, even without adding any new funds to my portfolio. Once you create critical mass in a dividend portfolio, the dividend income could compound to some pretty impressive figures over time.
How far along are you on your journey to financial independence? What are your plans after you reach the dividend crossover point?
Thank you for reading.
- How to retire in 10 years with dividend stocks
- Happy Financial Independence Day
- Margin of Safety in Financial Independence
- How to stay motivated on your road to financial independence
- From zero to $15,000 in dividend income in 8 years
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