How to Live Off Dividends in Retirement

By: Stephanie Faris | Reviewed by: Alicia Bodine, Certified Ramsey Solutions Master Financial Coach | Updated May 10, 2019

No matter how much money you save for retirement, you’ll always worry that it isn’t enough. With the market as it currently is, chances are you won’t be able to live off the interest on your investments. But you can potentially live off your investment dividends. The key is to carefully research each investment you’re considering and use tools like stock dilution calculators to ensure stocks with high-paying dividends aren’t losing their value.

Tip

You can live off dividends in retirement, but you’ll need to either start investing early or choose safe, high-yield stocks that cover your cost of living throughout your golden years.

Living off Dividends in Retirement

Unless you’re one of the lucky employees who have an employer-provided pension, you probably are on your own when it comes to funding your retirement. With the Social Security program in danger of running out of money, you may be counting on your 401(k) or individual retirement arrangement. One option is to invest in dividend-paying stocks, then live off the dividends either wholly or as a supplement to any other retirement income you’re getting.

Companies have three options when they make a profit on their stocks. They can:

  • Reinvest the earnings into the business.
  • Buy back stock.
  • Pay dividends to shareholders.

If you’re one of the lucky shareholders in such a scenario, you’ll get a nice chunk of cash every now and then that you can use to pay your living expenses. Add enough of these lucrative stocks to your portfolio and you may even be able to live on it. The key is to find stocks that regularly issue dividend payouts to their shareholders.

Compounding of Dividend Income

Your best bet if you want to live off dividend income in retirement is to get started as early as possible. In this scenario, you’re relying on the compounding of the dividends you’re earning between now and the day you leave the workforce. If you have a dividend-yielding stock that earns 3 percent, and you have $100,000 invested in that stock, a 3 percent dividend yield on that stock would give you $3,000 in dividends.

Even better, over time, the company may decide to increase the dividends it pays. Even if that amount stays the same, though, you’ll be earning 3 percent on the money you originally put in, plus your new earnings. If you have enough time to build it, this compounding gives you a nice cushion for your retirement.

Finding Dividend-Paying Stocks

A quick web search will connect you with numerous lists of dividend-paying stocks, but it’s important to look at the dividend yield, as well. NASDAQ maintains a list of dividend stocks, along with current dividend yield, current price, indicated annual dividend, ex-dividend date and pay date.

On a list like this, one of the most important factors is the indicated annual dividend, which shows you the amount a stock pays out each year in dividends, expressed as a percentage of its current share price. With the ex-dividend date, you’ll see the date at which you can qualify for the payout, and the pay date lists the next date a dividend payment is expected to be made.

Dividends and Share Dilutions

Equity dilution is an important concern for many investors who put their money behind a dividend-paying stock. As with a stock split, a dividend boosts the number of outstanding shares, which means the per-share price automatically drops. This happens because stock prices are determined by dividing the value of the company holding the stock by the number of shares.

It's important to monitor the value of your stock if the company regularly pays out dividends. A stock dilution calculator can help you determine how each move will dilute your stock, provided you have all the other information. If you begin to notice that the value of your stock is dropping too much, it may be worth considering making a change.

Monitoring Share Dilution

If you’re concerned about dilution affecting your investment, you can also simply keep an eye on the market. Over the course of six months to a year, you can see how your stock is charting. Although there are many factors that can generate sudden spikes, a dilution is often the root cause.

Before you can run the numbers through a stock dilution calculator or monitor the charts, though, it’s important that you fully understand how dilution is calculated. A company’s common shares include authorized shares, outstanding shares, restricted shares and float. Outstanding shares are affected by dividend payouts since there are now more outstanding shares floating around out there.

Dividends Increasing Shares

For you as an investor, though, the dividend payout actually increases the number of shares you have in the company. If you own 10,000 shares and the business behind those shares declares a dividend of 0.2, you would then own 12,000 shares since you’ll get 0.2 of a share for every share you own.

Still, this may not help you once you’re living off dividends, especially if it knocks the price down. You may own more shares of a particular stock after the dividend payout, but if the price has dropped significantly, it won’t work out to more money. You may even lose money on the deal, temporarily, at least. That in itself makes living solely off dividends challenging.

Receiving Dividends as a Shareholder

If you’ve invested in a stock that you’ve discovered frequently pays dividends, you may wonder what to expect when that first payout comes. As a shareholder, you have three options once the dividend has officially been issued:

  • Take the money and live on it.
  • Reinvest the money into the same stock.
  • Reinvest the money elsewhere.

Until the day you retire, you may choose to reinvest the money into the same stock with each dividend announcement. If enough people reinvest their dividends back into the same stock, you won’t have to worry about equity dilution, which is why it can be so unpredictable.

Avoiding the Yield Trap

Before you choose a stock solely for its dividend-earning potential in retirement, make sure you aren’t making a mistake. There is something called a dividend yield trap, which refers to stocks that are too good to be true. They pay good dividends for a reason, and that reason is connected to some flaw in the stock itself. Here are some red flags to watch for:

  • Excessive debt – Those high dividends likely won’t continue if the company is digging itself deeper and deeper in the hole.
  • Suspicious payout ratios – If payouts exceed 100 percent, or otherwise just seem high in comparison to earnings, the company may be relying on debt to finance its dividends.
  • Business issues – In some cases, businesses will issue dividends to keep shareholders engaged despite issues behind the scenes. It’s important to take a deep look at the stock’s performance in recent years.

It’s also important to note that a high dividend yield may not always be a bad sign. Companies that fall under the Real Estate Investment Trust and Master Limited Partnership categories are often required to issue a certain percentage of their income as dividends. Research isn’t limited to dividend-paying stocks, either. Investors should always take a close look at the recent performance of a stock before putting money into it.

Can You Live Off Investments?

Living off dividends works better as a strategy when you have other sources of income to supplement it. Experts often talk about the 4-percent rule, which states that you should withdraw 4 percent of your portfolio each year during retirement to live on, leaving the rest to generate interest.

Taking 4 percent a year can be tough for a retiree, though, as you see the funds in your portfolio start to dwindle. By investing in stocks and mutual funds that pay dividends, you can keep more of that portfolio intact since you’re drawing money that wasn’t there from the start. The goal is to find those dividend-paying stocks and get the earnings started as early as possible so that you’ll have a plan in place once you retire. With each year, you’ll earn more toward your retirement, which means over the course of 20 or 30 years, you could already have built a substantial nest egg off dividends alone.

Dividend-Earning Stocks After Retirement

For those who are already retired, though, getting started with dividend investing can be a bit trickier. You won’t have time for your dividend earnings to compound, so you’ll need to pull in enough immediately to cover your living expenses. For retirees, it’s important to pay close attention to the yield, focusing on those that have the highest yield while also checking to ensure you don’t fall into the yield trap.

You can find high-yield stocks that pay more than 4 percent, with some even extending all the way to 10 percent. Invest enough and you could certainly live off a 4 to 10 percent yield. To be safe, experts have a few tips when looking for a high-dividend stock:

  • Stay within your circle of competence. You’ll already have a jump on your research if you fully understand the industry and specialty of each company’s stock you choose.
  • Research not only the company you’re considering investing in but also the market performance of its competitors.
  • If an investment seems too good to be true, be wary of it.

Determining Your Retirement Budget

The truth is, whether you can live off your dividends in retirement or not also depends on what your monthly expenses will actually be. Look at areas where you can cut back in advance of retirement to keep those living expenses as low as possible. This may mean paying off your home and getting yourself completely out of debt beforehand, which could involve tightening your spending in the years leading up to retirement.

As you set a retirement budget, be as realistic as possible about how much you’ll want to spend. If you want to travel and dine out on a regular basis, you may need more to live on than someone who is content just staying home and maintaining a tight food budget. The less you’ll need to live on, the more likely your investment income will suffice.

Investing in Dividend-Paying Stocks

Once you’ve decided dividend-paying stocks are the route you want to take, there are two ways you can get started. The easiest is to invest in exchange-traded funds, which usually include multiple dividend-paying stocks. Your safest option will probably be to go with a low-cost fund that selects stocks that pay dividends directly from the Standard & Poor's stock index to keep your risk at a minimum.

Another, less straightforward option is to invest in individual stocks. This requires you or a broker to do screening on each stock to ensure it pays dividends and is a healthy option. Even if you trust in a broker, you should also do some research on your end to make sure you know what’s going on with your own money.

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About the Author

Stephanie Faris has written about finance for entrepreneurs and marketing firms since 2013. She spent nearly a year as a ghostwriter for a credit card processing service and has ghostwritten about finance for numerous marketing firms and entrepreneurs. Her work has appeared on The Motley Fool, MoneyGeek, Ecommerce Insiders, GoBankingRates, and ThriveBy30.

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