A loyal reader, Chereen, asked me the following question via email:

*“I would like to retire with a yearly income of $39,000. I wonder how much I need to put aside in order to receive this amount in dividends each year”.*

A blunt answer would be the following:

*“Assume a 3.5% dividend yield and divide $39,000 by 3.5%. You will get $1,114,285. This is your magic number”*.

Well, technically, if you invest $1,114,285 today and build a dividend portfolio paying a 3.5% dividend yield (which is still conservative), you will receive your $39,000 annually without touching your capital.

I wish the answer was just this simple. But it’s not. The magical number of $1.1M is only good for today and if you were to invest $1.1M in today’s stock too.

**The Power of Dividend Growth**

The answer to this magical question is a lot more complicated than this. I actually played with my Excel spreadsheets for a good 2 hours and wasn’t able to pull out a table that would satisfy my geeky dreams: showing that a smaller portfolio could generate the same $39K in dividends. How is that possible? It’s because of the power of Dividend Growth!

Take Coca-Cola (KO) for example; it currently pays a 2.90% dividend. However, the company is very keen on increasing its dividend. Therefore, it has doubled its dividend every 6-7 years for the past 50 years. So if you bought the stock 21 years ago, your dividend on your original investment is more likely to look like 9% than 2.90%. So imagine that 21 years ago, you had $300,000 to invest. Today, this $300,000 would pay $27,000 in dividend instead of $8,700 if you were to invest it today. All right, we need to compound inflation, $300K 21 years ago is now worth $478,686. Therefore, a similar investment would pay $13,881 in today’s dollar ($478,686 * 2.90%) as compared to $27,000 if you had invested the “same amount of money” 21 years earlier.

This was the premise and the easy part of my calculation. My brain almost burst when I tried to factor an annual contribution to the chart. For example, if you are 40 and expecting to retire at 65, you will most likely save money during the 25 years. It’s easy to know how much your current portfolio at the age of 40 will pay in dividends 25 years later. However, it gets complicated if you want to know how much each contribution will generate in dividends over time. Then, I would also have to factor in a capital gain somewhere. Do you get why I stopped my calculations? I would need an engineer or an actuary to translate what’s in my brain!

**An Example of Dividend Growth**

While I wasn’t able to pull a crazy calculation sheet that would make the whole financial planning industry jealous, I did run some calculations to see how much your dividend stocks would be paying after several years. I started with the assumption that you make regular contributions of the same amount over X number of years. So the chart would read as follow: if you invest in a dividend stock over 35 years with a dividend growth of 3% per year, you will earn an average of 6.05% on your initial investment:

35 years: 6.05%

30 years: 5.55%

25 years: 5.10%

20 years: 4.70%

15 years: 4.34%

10 years: 4.01%

In an ideal world, you would invest all your money and wait 35 years… and make a 9.85% dividend yield! However, you surely don’t have 300K at the age of 30 to invest and wait for your retirement ;-). On the other hand, you can see with this simple chart the huge power of dividend growth if you start investing young.

Based on these assumptions, a young investor, who starts investing $5,000 per year at the age of 30, will have invested $175,000 and receive $10,587 in dividends per year. The 10k is in today’s dollars not considering inflation.

**Dividend Growth Helps to Hedge Against Inflation**

If you live from your dividend payouts, you will be happy to know that you are able to hedge yourself against inflation if you pick the right stocks. In fact, if your portfolio shows a dividend growth of 3% per year in a tax free account (RRSP/TFSA or 401k/IRA), you will be 100% hedged against the rate of inflation.

**How You Can Calculate How Much You Need**

When I started writing of this article, I wanted to share with you an excel spreadsheet telling you how you can calculate how much you need to save in order to receive $39,000 in dividends at retirement. Unfortunately, this calculation is too complicated when you factor regular contributions, investment return, dividend growth and inflation. In fact, if you want to know how much you need to save, your best solution is still to have a financial plan done by a CFP. Then, you will know how much to save and at what rate. It will all be pretty easy to manage your portfolio after that!

Michel

We often hear that the rule of thumb is that you can withdraw 4% a year, during retirement, and theoretically it would last until your death. Is that a dividend portfolio? or just a regular balanced fund? I know it’s not Chereen’s question, but it would help establish her overall nest egg to reach her goal.

Poor Student

When you put it that way it would make a lot of sense for young investors to invest in dividend stocks even in lieu of greater growth from other stocks. I have been trying to create a good balance between growth of capital as well as receiving dividends, and taking this into account might persuade me to increase the allocation to dividends even though I do not need that income for a long time.

Mike

@Michel,

If you have a balanced portfolio and withdraw 4% of your portfolio, chances are that you won’t survive your investments and you will be making a lot of happy heirs ;-).

The same rationale can be applied to a dividend portfolio. If your portfolio generates a 3.75% – 4% of dividend, you will probably won’t withdraw enough to use all your money (even if you increase your withdrawas according to the inflation).

@Poor Student,

Dividend growth takes its power through time. Someone, like me, who invest most of his money in dividend stocks at the age of 30 won’t have to worry much at 60 🙂

Rob

I too have spend many hours on a spreadsheet to try to calculate this and I have a model that works reasonably well for me. There are 3 growth factors to consider -contributions, dividend re-investments and dividend increases – and it gets quite complex trying to model the effects of each. One thing i will point out, is that the valuation of the portfolio at any point in time is irrelevant. What is important is the income generated. That being said, when you get to retirement age and you have successfully built up your income stream to $39K, you will likely find that the market valuation of your portfolio is going to be around the $1.1m mark.

Here’s a simplified calculation example starting with 100K. You can see how quickly the annual income grows:

Year 1 dividends received = 3,500 (3.5% of 100K)

Year 2 contribution = 10K

Year 2 dividends received = 3,500 * 3% div increase = 3,605

+ reinvest of 3500 * 3.5% = 122.50

+ contribution 10,000 * 3.5% = 350

= total income Year 2 of $4,077.50

Year 3 dividends received = $4,077.50 * 3% div increase = $4,199.83

+ reinvest of 4077.50 * 3.5% = 142.71

+ contribution 10,000 * 3.5% = 350

= total income Year 3 of $4,692.54

Joe @ Retire By 40

@Michel When you retire, you probably want to put the bulk of your portfolio into a more stable investment like bonds. What happens if the market crashed and your stocks cut the dividend? You will have to sell at a cut rate price to get your living expense.

Great post. I’ll need to keep dividend growth in mind as well as the current dividend for future investments.

Irving Rivera

Mike; send me that data for those 25 years. I will create that excel spreadsheet. That is my profession, I am Industrial Engineer.

PS: is going to be free of charge.

My Own Advisor

Nice post.

Unlike what Joe said, my plan is to have a nice split of bond ETFs and dividend paying stocks in my portfolio. I currently own about 25 companies, over half of them DRIP synethetically today and buy more shares for free every quarter. I love it. 🙂 Market goes up, I get paid. Market goes down, I get paid. Rinse and repeat….

If I can own about 40-50 companies eventually, that’s my sweet spot, then the chances of all these companies going under, taking dividend cuts, is virtually nil in any bear market.

I have nothing against equity ETFs, I own them myself, but I would advise any young investor to hold at least a few blue-chip dividend paying stocks and never touch them, reinvest dividends over 40 years, and those stocks will pay for your heat and hydro bills and then some with the income paid when you retire.

What could be better?

Cheers,

Mark

RICHARD

Well the only RRSP I can track is a LIRA. Started @72K in 2003 and now at 155K in nine years. As I can not contribute anything it is easy to figure out I am pulling a bit over 8% on an annulaized basis, including stock appreciation. All stock paying dividends which are re-invested. Even lost a bit on NT. Aside from that my TFSA is up over 20%, again all in stock,and that was with a 2.5% GIC in the first year. I can’t complain on that either.

I would not have been saying this in 2009 but the dividends still kept rolling in even then. Was a great time to buy!

So, YES, dividends are a great way to build and diversify. Just keep in mind that when you start out a 5% div on 1K is only $50. But when you are up to 100K it is 5K. And that makes for a nice sum to buy more stock.

I like to stick with the blue chips mainly but sniff around for other stocks that I feel comfortable with. Helps to keep you diversified.

Have yiu gotten rid of that non-dividend stock Mike?

Mike

@Richard,

nope, I’m still stuck with VNP…. waiting for another quarter to see if losses will be repeated or it was just a bad timing….

Miiockm

If you had $1.1 million saved up at retirement couldn’t you just start drawing from that.

Mike

@Miiockm,

You can and you will probably have to anyway. But if you have to live for 35-40 on 1M$, you better have some dividend paid as well if you want to be able to enjoy life.

cheers,

Mike.

Kanwal Sarai @ Simply Investing

Great post Mike! I too have tried to come up with a magic spreadsheet that could automatically tell you how much money to save for retirement, but like you said “this calculation is too complicated when you factor regular contributions, investment return, dividend growth and inflation”.

My goal has been to save as much as I can and invest in quality dividend paying stocks when they are undervalued. Each year the amount of dividends I receive keeps on increasing and it has been doing this for the last 13 years….so I must be doing something right. 🙂