Wednesday, October 14, 2015

From zero to $15,000 in dividend income in 8 years

Back in May 2007 I had a net worth of $2,000.

I then promptly exchanged most of that networth for an old vehicle so that I can get to work. I sold that same vehicle less than two years later for a loss of 80%.

Luckily, I had better luck saving a large portion of my income every month, and investing it wisely. My savings rate has consistently been above 50%.

Right now, my expected annual dividend income is scheduled to cross $15,000 for the first time ever. This number is calculated by multiplying the current annual dividend per share on each investment I own, times the number of shares I own. This includes everything I own in taxable and tax-advantages accounts such as my 401 (k). In other words, if I do not add any new cash to my investment accounts, and I do not reinvest dividends, I will be able to generate $15,000 in annual dividend income going forward.

As you can see from the chart above, my annual dividend income has been increasing over the past five years. This is due to dividend growth from the companies I own, reinvestment of dividend income, and from new capital that is put to work. The amounts for 2015 include the first 9 months of actual dividend payments and my estimate of the dividend income for the last three months of the year.

There is a difference between actual dividend payments and forecasted dividend payments because I have added new capital to work throughout the year, companies have raised dividends throughout the year, and I have also reinvested my dividends into more shares throughout the year. For example, if I owned 100 shares of Coca-Cola at 12/31/2014, I would have expected to generate $122 in annual dividend income based on the quarterly rate of 30.50 cents/share. Since the dividend was increased to 33 cents/share  in February 2015, the expected dividend income is now $132/year. If I reinvest those dividends back at Coca-Cola at a 3%/yield, chances are that this expected annual dividend income could easily top $136/year ( and that's from just one stock position).

As I wrote in an earlier post, I spend approximately $1,500/month on average. However, I do want to have some margin of safety in financial independence, which is why I view a range of $1,500 to $2,000/month as a more sustainable one.

This means that I can cover anywhere between 7.5 to 10 months of expenses from dividend income alone.

So how did I manage to get there?

The answer is pretty simple actually. It has more to do with following factors within my control, than being a brilliant investor ( though I sometimes fancy myself as such)

1) Expenses

I believe that I can manage expenses to a large degree. The major expense categories include housing, food, transportation and taxes. I have always managed to keep housing expenses low by renting. I have kept transportation expenses low by living close to work. I have kept food expenses low by cooking for myself and brownbaging lunch for work. That way I eat healthier and avoid paying unnecessary high costs for lunch. I do spend funds on going for drinks though. Diageo is not going to research itself after all.

I did a bad job of minimizing tax expenses for the first five years of my journey. I had my a-ha moment when I read how the blogger from Budgets Are Sexy discussed how he saved tens of thousands of dollars by funding a SEP IRA in 2012 and 2013. After this initial dose of inspiration, I have been maxing out my 401 (k), SEP IRA, Roth IRA and now also HSA. The more money I keep from the taxman, the more money I keep compounding for myself.

I have found that by keeping expenses low, I need less money in retirement. For example, if I needed $40,000/year to live off, and my portfolio yielded 4%, I would need a nest egg of $1 million ( or $1.3 million at 3% dividend yield). However, if I cut my expenses by $10,000/year, I also reduce the need for savings by $250,000 - $333,333. In this scenario, for each $1,000 in annual expenses that are reduced, the investor needs $25,000 - $33,333 less money to invest.

In addition, if I spend less every month, this means that I can save more. This in turn reduces the time it takes for me to accumulate sufficient savings.

The higher the savings rate, the less money a person needs in retirement. The higher the savings rate, the quicker it takes to accumulate enough money for retirement. If I save 50% of income, I can retire in less than 20 years. If I save 75% of income, I can retire in less than a decade.

2) Investments

I cannot control the future total returns of my investments. I can control the types of investments I choose. I have chosen to invest mainly in dividend growth stocks, because they provide me instant feedback in the form of cash dividends every quarter. It is very easy to check how I am doing relative to my goals by using the dividend income from my portfolio. In addition, I find it helpful to have multiple layers of safety when I create a portfolio of dividend growth stocks. Those layers include solid competitive advantages, margin of safety in dividends, attractive valuations at entry, and diversification.

It is much easier to model retirement income using cash dividends. When the dividend income from my portfolio covers my expenses, I can consider myself financially independent. Receiving regular dividend payments that grow faster than inflation makes it very easy to pay for expenses. After all, when you work you receive cash to pay for expenses. So with dividends, the transition to retirement should be pretty easy. This is no rocket science, but common sense.

For example, if I needed $24,000/year to live off, but my portfolio yields 3% and generates $18,000/year, I would instantly know that I am 2/3rds on my way towards financial independence. If those dividends also grow organically by 6% - 7%/year during that period, and reinvest those dividends, I will reach this goal in a little more than three years.

Alternatively, if there was no organic dividend growth in that portfolio, I would have to reinvest those dividends back for ten long years. Otherwise, I would have to find a way to put $150,000 to work. This example is a long way of saying that there is a value to dividend growth in retirement planning. With growing dividends one can feel much more secure.

3) Income

I have not shared my income on this site, because I am prohibited from disclosing it per my contract. However, it is safe to say that my base job income was never 20% more than the median household income salary in the US.

I have managed to earn extra money by earning some advertising income from this site, as well as occasionally writing a freelance article or two. Of course, blogging is hard work that is not paid well (and quite frankly you are often under appreciated as well). I would have likely made more money as a cashier at Wal-Mart, for the amount of time I have spent blogging. I have enjoyed writing, and interacting with smart investors, so I would not have had it any other way. This paragraph is a long way for me to state that although I have earned money from this site, it has not been anything too exciting. Plus, it fluctuates greatly, so it usually is feast or famine on a monthly basis.

There is a nice bonus about investing in dividend paying stocks that send you cash every quarter. The ability to generate more cashflow is not widely understood by most people. The more I invest, the more my income is increased. Let’s see what this means in a scenario where a single person earns $50,000/year, and saves $25,000/year. Let’s assume that this money is invested in a portfolio of dividend paying stocks yielding 4%, that grow dividends at say 4%/year on average. Let’s assume that in year two, the person is still paid $50,000/year ( it is a bad economy according to the bossperson) and they manage to save $25,000/year. However, the person would also earn $1,000 in dividend income from the dividend seed that was planted in year one. This increases the total annual income by 2%, but increases the amount of savings by 4%. Every little bit counts on the quest towards financial independence.


What is the purpose of this post?

The purpose is to show that someone who doesn’t earn that much, can still have a shot of attaining financial independence early in life. This is achieved by living frugally, which in effect results in higher level of savings as a percentage of income. This frugality also results in the need for a smaller nest egg in retirement. The other lesson is to keep investing simple, by creating a strategy that fits your personality, so you can stick to it through thick and thin. For me, I find it easier to track percentage of expenses that are covered by dividend income. When you receive cash dividends every quarter that cover or exceed your cash expenses, it makes sense that you do not ever have to work for money again ( though you will pursue activities that might bring in accidental income).

With every investment I make, I increase my annual cash flow. In other words, for every $1,000 I invest today, I can expect to generate anywhere between $30 - $40/year in cash. This amount will also increase over time. By investing in income generating assets, I am actually able to earn more and therefore save more. This is a vicious cycle.  If my wage was $20/hour, I am essentially buying 1.5 – 2 hours of freedom with each $1,000 that I put to work in my portfolio of quality dividend payers. My money will work hard for me 24 hours/day, without taking any time off. The raises from my dividend portfolio will also be higher than the raises I get from regular job of filing TPS reports.

Others have done similar things by investing in real estate, or index funds for example. The possibilities are infinite.

How much annual dividend income are you generating from your dividend portfolio? What is your target annual dividend income?

Thank you for reading.

Full Disclosure:

Relevant Articles:

How to increase your dividend income
Why am I obsessed with dividend growth stocks?
How to stay motivated on your road to financial independence
How to retire in 10 years with dividend stocks
My Dividend Goals for 2015 and after
My dividend crossover point

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