Living off a dividend portfolio can be a great way to generate income in retirement or supplement your income stream. Dividend-paying stocks are companies that pay out a portion of their profits to shareholders in the form of dividends. By investing in a well-diversified portfolio of dividend-paying stocks, you can generate a regular stream of income without having to sell your shares.
Below are five steps to guide you in achieving this goal:
Step 1: Determine your income needs
Setting yourself up to live off a dividend portfolio starts with determining your income needs. Calculate your monthly expenses and subtract any sources of income you have from other investments or pensions. This will give you an idea of how much income you need to generate from your dividend portfolio.
Let’s say your monthly expenses are R25,000 and you receive R5,000 per month from a pension fund or interest. This means you need to generate R20,000 per month from your dividend portfolio. Multiply this amount by 12 to get the annual dividend income needed.
Step 2: Build a diversified dividend portfolio
The next step is to build a diversified dividend portfolio. This means investing in a mix of stocks from different sectors and industries. A well-diversified portfolio can help reduce your risk and increase your chances of generating consistent income.
Here’s an example of a diversified dividend portfolio:
- 30% in Mining (e.g., BHP Billiton, Sibanye Stillwater & Exxaro)
- 22.5% in Real Estate (e.g., Vukile & Stor-Age)
- 20% in Retail (e.g., Shoprite & Woolworths)
- 15% in Telecom (e.g., MTN & Vodacom)
- 12.5% in ETFs (e.g., Satrix Divi Plus & Satrix Resi)
Step 3: Calculate your expected dividend income
Once you have built your dividend portfolio, you need to calculate your expected dividend income. This can be done by multiplying the current dividend yield of each stock by the number of shares you own. The dividends earned on the ETFs in your TFSA will not be taxed. The balance of the dividend income will be taxed at 20%. Remember to account for the fact that you cannot invest more than R500k into a TFSA.
You can also work backwards. Take your annual income needs and divide it by the average dividend yield of your portfolio. If your annual needs are R240,000 after tax and you invest in a portfolio with a 7.5% average after-tax annual yield, you will need R3.2 million invested. See the below image for several examples.
Step 4: Monitor your portfolio
It’s important to monitor your dividend portfolio regularly to ensure that your stocks are still performing well and paying consistent dividends. If a company cuts its dividend or experiences a decline in performance, you may need to consider selling that stock and replacing it with another one with a better track record.
Step 5: Consider the impact of inflation on your dividend portfolio
While building your dividend portfolio, one major risk to be aware of is the impact of inflation. Inflation eats away at the value of your income and erodes your purchasing power over time.
If you have R1,000,000 in your dividend portfolio that yields a 4% dividend distribution, you’ll receive R40,000 per year. With a 6% inflation rate, goods and services will cost 50% more within 9 years. If your dividend distributions aren’t keeping up with inflation, your ability to pay your bills and enjoy your lifestyle could be greatly affected. That’s why it’s important to select companies that have a history of increasing dividend distributions that outpace inflation.
Last words
Living off a dividend portfolio can be a great way to generate income in retirement or supplement your income stream. By determining your income needs, building a diversified dividend portfolio, calculating your expected dividend income, and monitoring your portfolio, you can create a reliable source of income while holding onto your shares.
Remember, while dividend-paying stocks can provide a steady stream of income, they aren’t risk-free investments. It’s important to research and invest in high-quality companies with a strong track record of paying consistent dividends. If you need to, consult with a financial advisor to ensure that your investment strategy aligns with your financial goals and risk tolerance.
Rochelle Warries is a qualified chartered accountant with 16 years of experience and a seasoned stock market investor. Her passion is helping novice investors build healthy investment portfolios through financial education.
She is founder of Soul Financial, a website offering financial education and coaching. You can find her on Twitter: @soulfairy3