WMT - How To Live Off Of Dividends For Potentially Life-Changing Passive Income

2023-12-06 08:35:00 ET

Summary

• Living off of dividends can be truly life-changing.
• We discuss why and how to do this.
• We also share a sample portfolio for making this dream a reality.

Achieving financial independence through passive income can truly be life changing. In this article, we will discuss why this is, explain why dividend growth investing is one of the best methods for achieving financial independence through passive income, share some key principles for successfully living off of dividends, and then share some of our top picks for building a portfolio that can help make this dream a reality.

Why Becoming Financially Independent From Passive Income Is Life-Changing

Achieving financial independence through passive income is the ultimate goal for many investors because this approach to retirement planning represents more than just a smart financial strategy; it is a gateway to a life-changing level of personal freedom and security for several reasons.

First of all, receiving a consistent and reliable stream of cash flow that is independent of active employment allows retirees to support themselves and design a custom daily routine without the need to work.

Second, funding your lifestyle with passive income means that your expenses are covered with recurring cash flow that is generally much less volatile than daily stock quotes. Instead of pouring all of your savings into a highly volatile bond ( BND ) or stock ( SPY ) ETF and hoping that the market cooperates enough so that you do not have to sell shares and make withdrawals during market crashes and rapidly cannibalize your life savings, living off of passive income means that you never have to worry about selling principal and instead live off of the cash flow. As a result, you can be almost entirely agnostic to what is happening in the market at any given time and instead keep calm and let the passive income flow.

This leads to the third major life-changing benefit of achieving financial independence through passive income: knowing that your investments will generate sufficient cash flow to cover your living expenses - regardless of ongoing market volatility - brings general peace of mind, reduces stress related to financial uncertainties, and offers the freedom to pursue passions, hobbies, and personal goals without the constraints of a traditional 9-to-5 job or having to worryingly monitor financial markets out of fear of a sudden stock or bond market crash.

Ultimately, retiring on passive income is life-changing because it enables you to plan with a much greater degree of certainty and thereby be liberated to focus on your life purpose and passions instead of hoping and worrying that you have saved enough money to last through your retirement.

Why Dividend Growth Investing Is Possibly The Best Way To Achieve Financial Independence

While the destination sounds great, what is the best way to get there? Dividend growth investing stands out as arguably the best approach to achieving financial independence through passive income for several key reasons.

First of all, companies that consistently pay and grow their dividends are often well-established and financially strong. For example, Dividend Aristocrats ( NOBL ) and Dividend Kings - those companies that have paid out growing dividends every year for 25 and 50 years, respectively - include the likes of Coca-Cola ( KO ), McDonald's ( MCD ), Johnson & Johnson ( JNJ ), Walmart ( WMT ), and Lowe's ( LOW ), companies that are household names, have proven to be highly profitable through all sorts of economic climates and numerous waves of technological disruption and are highly unlikely to run into financial trouble anytime soon. This stability is crucial for long-term income generation, particularly in retirement planning, where the preservation of capital and the ability to grow dividends in a manner that keeps up with or even beats inflation is as important as current income generation.

This leads to the second advantage of dividend growth investing: the dual income growth aspect of dividend investing is another compelling factor. Not only do investors receive regular dividend payouts, but they also benefit from the potential capital appreciation of the stocks themselves as the businesses retain a portion of earnings net of dividend payouts to grow their earnings and ultimately dividends per share over the long-term. Moreover, reinvesting dividends accelerates the compounding effect, significantly enhancing long-term returns. This reinvestment strategy can lead to exponential growth in a passive income stream over the long-term, thereby accelerating the process of achieving financial independence.

Inflation protection is another notable advantage of dividend growth stocks, as many dividend growth companies increase their payouts at rates that - over the long-term - outpace inflation. This dynamic ensures that the purchasing power of your income does not erode over time, something that cannot be said for bonds and other fixed income investments.

The historical performance of dividend growth stocks further accentuates the case for them being an ideal vehicle for pursuing financial independence, as history has shown that dividend growth stocks tend to outperform the broader market over the long-term.

How To Live Off Of Dividends For The Long Term

Now that you know the what and the why of achieving life-changing retirement passive income from dividends, now we will discuss the how . After all, you cannot simply buy any dividend growth stock and assume that all will go well forever. Living off dividends in retirement requires a strategic approach to ensure that the income generated comfortably covers living expenses for many years and potentially decades into the future. This involves careful planning, portfolio diversification, and a thorough understanding of dividend growth investing methodologies. Here are a few principles to guide you on your journey:

1. Build a Diversified Dividend Portfolio: Diversification is paramount in dividend investing. A well-balanced portfolio spread across different sectors can help mitigate risk and ensure that your portfolio generates consistent income that comfortably meets your living expenses through economic crises, recessions, economic expansions, pandemics, periods of significant technological disruptions, and/or periods of high inflation. This diversification also helps in protecting the portfolio against sector-specific downturns or geopolitical risks that might impact specific sectors more than others.

2. Focus on Dividend Growth, Not Just Yield: While high-yield stocks can be attractive and can certainly accelerate the process of achieving financial independence through passive income, focusing solely on yield can be misleading over the long-term. Instead of simply chasing the highest yielding stock in the market, investors should prioritize companies with a history of consistent dividend growth and have well-covered dividend payouts. These companies are often more resilient and capable of increasing dividends over time, which is critical for keeping up with inflation and maintaining purchasing power. If a company can no longer support its high dividend payout and has to cut it, the stock price often plummets either shortly before in anticipation or shortly after the announcement (and many times it drops both before and after the dividend cut is announced). This can crush an investor's retirement dreams if they have too much invested in that single stock because their current income plummets while their principal also declines meaningfully, preventing them from recovering their lost passive income by recycling the capital elsewhere into an alternative investment.

3. Understand Withdrawal Rates: Establish a sustainable withdrawal rate from your dividend income. A common rule of thumb is the 4% rule, but this may vary based on individual circumstances and market conditions. If your portfolio is generating a sustainable and growing yield of, say, 7%, you can probably afford to plan on withdrawing a higher percentage of it than just 4%. 5% or even 6% may do in this scenario, depending on what you are invested in, how much health insurance and other contingency planning you already have in place, and how long of a retirement you are planning for. Keep in mind that passive income tends to be much less volatile than publicly traded stock and ETF prices, which is the beauty of this approach, so you may not have to be quite as conservative in withdrawal rates as you would be with other retirement plans. Note that this is not financial or retirement advice, so be sure to meet with a financial advisor and/or financial planner to determine what works best for you.

4. Regular Portfolio Review: Finally, and perhaps most importantly, regularly review your portfolio. Prune the stocks that have seen their dividend growth falter and/or are trading at rich valuation premiums such that their dividend yields are no longer attractive and recycle the capital into higher yielding/faster growing stocks that still meet your quality and diversification criteria, so long as such trades do not run up a huge tax bill. Opportunistic and tax-efficient capital recycling is a great way to accelerate the wealth and passive income compounding process.

Sample Long-Term Dividend Growth Investments For Financial Independence

While everyone's portfolio will look different and there are many ways to approach this process (some prefer holding 50-100 stocks, whereas others are fine with holding fewer stocks that they are more intimately familiar with), here are a few stocks and ETFs that could make for good core holdings in a dividend growth portfolio designed to throw off ever-growing passive income for years and even decades to come:

1. Dividend Growth ETFs: The Schwab U.S. Dividend Equity ETF ( SCHD ) and Vanguard High Dividend Yield Index Fund ETF ( VYM ) can provide a foundation of diversified, high-quality dividend-paying stocks for a dividend growth portfolio. Both provide meaningfully higher yields than major equity indexes while also posting impressive strong dividend growth track records. Their low expense ratios and emphasis on defensive sectors such as financials, consumer defensive, healthcare, and industrials, along with some exposure to technology, make them attractive and very passive options. In fact, for investors with little to no knowledge of investing or with no desire to spend time on researching stocks, these can easily occupy the vast majority of their portfolios. To learn more about how VYM can help you on your journey to financial independence, click here . To learn the same about SCHD, click here .

2. Midstream Infrastructure Stocks ( AMLP ): Stocks like Enterprise Products Partners ( EPD ), Energy Transfer ( ET ), and Enbridge ( ENB ) offer a mix of high yield, strong investment grade balance sheets, solid long-term dividend growth potential, and stable cash flows from defensive business models. Their large and diversified presence in the energy supply chain, often underpinned by long-term contracts, provides cash flow stability and consistent passive income to investors. EPD and ENB in particular have impressive 25+ year track records of growing their dividends, whereas ET offers a higher current yield and an impressive recent streak of growing its payout quite aggressively. To read more about EPD, click here . To read more about ENB and ET, click here .

3. REITs ( VNQ ): Realty Income ( O ) stands out as arguably the best overall REIT pick for a long-term dividend growth portfolio due to its high current dividend yield, 25+ years of dividend growth, monthly dividend payouts, and proven recession resistance. Its diversified real estate portfolio and triple-net lease structure provide stable cash flows, while its attractive current valuation, A- rated balance sheet, and proven track record of delivering inflation-beating dividend growth and market-crushing total returns make it a compelling sleep well at night investment. To read more about O, click here .

Combining high yield blue-chip dividend growth REITs and energy infrastructure with broadly diversified dividend growth ETFs (that admittedly lack much real estate and infrastructure in them) can produce a well-rounded portfolio with a reasonably attractive mid-single digit current yield and high single digit annualized dividend growth potential. This sets up retirees well for generating sufficient current income alongside comfortably beating inflation over the long-term. Again, these are merely ideas and does not constitute investment advice. Speak with an individualized financial advisor and/or planner to determine what suits you best.

Investor Takeaway

By harnessing the power of dividend growth investing, individuals can build a sustainable and resilient income stream that not only withstands market volatility but also grows faster than inflation over time. This enables you to enjoy both peace of mind in the present and ideally leave a meaningful inheritance to your heirs decades after you retire. The key to success lies in constructing a well-diversified portfolio, focusing on companies with a strong history of dividend growth, and adapting to changing market conditions through regular portfolio monitoring and opportunistic capital recycling.

Hopefully the principles and ideas shared in this article will prove useful to you on your journey.

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