Retiring on Dividends: When is the right time?

I’ve never really thought too long or too seriously about when or if I could “retire” with passive dividend income before, however seeing a number of blogs start to discuss this issue has got me thinking about this a little more seriously. 

 

One of the great things for me about having a passive dividend income stream has been the ability to use it to nicely supplement our lifestyle. Its allowed my wife and I to accelerate mortgage repayments in a way that wouldn’t otherwise be possible, purchase vehicles with minimal loans. All the things that one otherwise wishes they could do with a few extra dollars.

But having seen some others use their passive income to completely exit the workforce, has made me think further about if this is possible and when it could be done.

I think there are really two aspects to thinking through this issue. The first is what does it actually mean to be “retired”, and the second is how much money do you need to do it

What is retirement ?

Retirement seems to suggest putting your feet up and officially checking out. Sipping some drinks down by the pool. Playing a few rounds of golf. Its an attractive vision, but I think after a few days I would likely get bored of it.

Work  gives me  mental stimulation and satisfaction and I think I would really miss not having that any longer.

Having said that, I think the spirit of early financial independence is very important because you never know when something you enjoy may be turned into a miserable experience because of changes in your work situation.

What is financial independence?

In my view, its not necessarily income replacement. I think its covering your expenses, having an additional buffer of close to 10%, and increases in your income to cover inflation from year to year.

The beautiful thing about a dividend growth strategy is that you get an ever rising income stream to at least give you the inflation coverage, so if you can work out your a stable level of expense coverage, then you are on the well on the way.

And how do you deal with unexpected blow outs in expenses? This is where an emergency fund comes in.

I’ve never believed in having an emergency fund, because I’ve always believe that my $25k dividend income effectively acts like an emergency fund. Living off dividends probably means that I should have at least a 6 month coverage of expenses in a separate emergency fund.

So now the real question. How much do I need to cover to be financially independent?

How much do I need?

I generally have the view that for any budgeting exercise, you want to run the numbers over a 3 month period and remove any one off expenses.

Unfortunately, I’m not pleased to report that we don’t even hold a candle to Dividend Mantra as far as his disciplined approach to savings and monitoring all his expenses.

Our average expense run rate for the 3 month period I looked at is close to $4500 per month.

One of the big things that I noticed in my expense review was that childrens expenses and the mortgage make up a big chunk of that $4500, close to 75% of it in fact. Between diapers and formula, and childcare expense, the bills for kids start to add up. And I shouldn’t just lump the blame totally on just the kids here! There are a few lunches, and some nice bottles of wine that show up on our expenses also!

My takeaways

1. The amount of passive income you need to achieve financial independence really depends on your personal situation. As a family, we have a bunch of expenses that you don’t have when you single. Many of these are what I would call essential expenses, rather than discretionary (ie/ we want to make sure the kids aren’t deprived of diapers!)

2. When you retire will be influenced by what you choose to give up and how aggressively you cut out expenses.  We have to face up to the fact that we aren’t prepared to give up a few of the small comforts like some nice lunches and dinners out that we enjoy today. While these things are small, they still add up, and still delay the savings/investing goals.

3. We will receive an “expense tailwind” in the next 5 years as our kids transition out of childcare, diapers, formula and as our mortgage gets paid off. This will mean financial independence will be a real possibility at that time, particularly if we can hit our goal of $50k/yr in dividend income in 5 years.

Of course, the inevitable cycle of needing to save for the kids college will soon start, but hopefully our dividend income will have risen substantially during that time to meet this next expense challenge.

I guess its a good thing i still like working :)

Comments

  1. I agree that the prospect of early retirement depends strongly on your personal situation, especially being single vs. having a family. I am single with no dependents, so I can save and invest a lot now, but that could change down the road.

    Regarding an emergency fund, your level of dividend income can certainly fill that role. However, investors with less dividend income may want to have a cash reserve outside of their portfolios. In my own case, a cash reserve has come in handy as a sort of “float” for work-related travel where I initially pay out of pocket and then get reimbursed later. That way, I don’t have to deplete my checking account as I wait for reimbursement.

    • Integrator says:

      Hi DGM,

      I totally agree the need for an emergency fund. I do struggle with the need to have so much cash parked idle, effectively earning a negative rate of return after inflation. Further the opportunity cost of say $20k, not being investing earning compounded dividend returns is tough to stomach. I think its fortunate the my dividend cushion can fulfill that role. Not having an emergency fund exposes you to excessive risk if there’s an unexpected event in your life. I view it as self insurance to some degree, and insurance always comes at a high cost !.

      I was surprised at how much we are spending on kids expenses. It came as a bit of a shock frankly. Goes to show a focussed approach on tracking expenses regularly is important. I hadn’t updated our budgets since the birth of our son early last year, which, had I done so, would have revealed the extent of the expense.

      I’d take advantage of you single status to really accelerate your dividend income and get it to the point where it gets to auto pilot. Compounding over the years will take care of the rest for you if any when your family circumstances change.

  2. Dividend investing is my retirement plan. I am fortunate to have a job that I enjoy and don’t mind doing for the next 30 years or so. However, it is very nice to have the OPTION to work or not. I believe keeping my income will help me dividend investing grow even faster because I will be able to keep contributing. Versus having to start withdrawing at an early age.

    We are currently in your same situation with kids, diapers, daycare, etc. We pay $300/week for daycare and that’s for one child….absolute insanity. Once our children are in school full time my wife will be able to go back to work full time and put our savings and dividend investing into overdrive.

    • Integrator says:

      Hi Marvin,
      Thanks for swinging by. I hear you on the the kids expenses! Until you go through and quantify exactly how much you are spending on the kids expenses there’s a tendency to underestimate these. I certainly did!

      Its great to meet another likeminded investor looking at dividends for an accelerated retirement. I think you hit on the key thing which is the option to work or not, and specifically what type of work. Having some passive income from dividends gives you the option to do a range of things, and protects you if the level of satisfaction from your experience at work changes. If there’s some kind of reorganization for example, a new boss or just general changes in your life.

      In my view, you can’t put a value on the peace of my mind that you get from knowing there’s a safety net there to meet your expenses. Its priceless

  3. I draw big distinctions between retirement and financial independence. I consider financial independence reached the minute my investment income crosses my savings. That’s the point where I can get laid off and take my sweet time finding a new job. Since I obsessively track my expenses, I know exactly what that point will be.

    Retirement, to me, involves a substantial amount of not working. And probably engaging in far too much travel. I might do something as a hobby, but it would obviously be a hobby job, not a job job.

    If I was going to “retire” off of dividends, the big question becomes how much do I like/hate my job. The closer that needle moves to “like” the more dividends I need before I consider retiring. The closer that needle moves towards “hate” the less dividends I need.

    • Integrator says:

      My FI,

      That’s a very interesting perspective on the “retirement” point. I like your notion of a “job utility score” if you like. The greater the utility the job gives you, the more passive income you would need to be pulled away from the job. I think in my case right now, that “job utility score” is pretty high (ie I’d want a lot of passive income to pull me away from the job). but i can see that if its a job that you hate and you want to leave, the passive income amount that you would want would probably be a lot closer to your “financial independence” number (ie where you passive income just meets/exceeds your expense).

      I think for me one of things I’d want to explicitly factor into that assessment is the mental stimulation from not being in a “job job” and how i’d otherwise get that in retirement. I have to say as of right now, blogging and reading others blogs is providing me with a lot more of an ability to exercise and test my thinking than I initially thought it would, so activities like this would certainly help make up for the loss of mental stimulation from work!

  4. What I like about Financial Samurai and some others out there is that they talk about retiring early, but they do still work. They just do the kind of “work” that they like. Which is awesome. And I like that idea for retirement — keep working a little. And that way we don’t become sedate and braindead from doing nothing all day, dudes!

    • Integrator says:

      Hey TB,

      Thanks for stopping by!. Yeah, I hear you on working in retirement. The thing about the early retirees is that I’m sure they have this inherent drive to keep going and keep achieving. Thats probably the only way that you can accelerate your savings rate and develop all of these passive income strategies so early to allow you to retire.

      To all of a sudden be in a financial situation where you can retire, and then just all of a sudden sit around and do nothing? That’s probably a strange concept for them, which is why you want to keep doing something that interests you and that you are passionate about, not doing something that you have to to get a paycheck and put food on the table.

  5. Robert Burke says:

    It’s very difficult to know when your dividend stream can pay your expenses when you have kids. I think you are greatly underestimating the cost of the kids. As they get older, there will be private school, camp, vacations at Disney, Air Jordan’s, hockey or football equipment, cell phones, iPads, university, etc, etc, etc.
    Good Luck!

    Robert

    • Integrator says:

      Thanks for the comment Robert. You raise a fair point. I think we will only get a good sense of this when are kids start getting older. Fortunately, the rising income stream will grow over time, such that when they are college going age, I’d expect the dividend income to have rise fairly significantly from where it is today. We expect to still be working beyond our dividend income hitting $50k/yr, possibly slightly more relaxed jobs though!

      Integrator

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