Some companies pay out money to their shareholders regularly in the form of dividends. Investing in these dividend shares is a common passive income idea. I use it myself.
Those payments could be a supplement to a regular income. But what if I decided I wanted to live off them, either now or when I retire? Is that possible?
The role of dividend yield
The answer to that question involves several elements. The amount I can hope to receive from shares depends on how much I invest and what is known as the dividend yield. Yield is the total dividends I should get from a share in one year, expressed as a percentage of the purchase price.
Imagine I invest £1,000 in shares with an average yield of 5%. I would hopefully earn £50 each year from those dividend shares.
Yield varies depending on the share price when I buy. So if I buy shares when their price is low, my yield will be higher than buying the same shares at a higher price.
Meeting my target
Knowing that, I can then understand how much I would need to invest to live off the dividends, based on my cost of living. That target amount will likely be different for each person based on individual circumstances.
Imagine I need £2,000 per month in living costs. That is £24,000 per year. If my shares yield an average 5%, I would need to invest £480,000 to target that level of dividend income.
That is almost half a million pounds, which is a lot of money. But if my target is to live off the dividend income when I retire, I could aim to build up to that size of dividend share portfolio over time.
As an example, imagine I want to retire in 30 years with monthly dividend income of £2,000. I could invest £580 every month in shares with an average yield of 5% starting now and compound the dividends. By the end of the 30-year period, I should own shares worth a little over £480,000 paying £24,000 in dividends annually. That is my target!
Finding the right dividend shares
The above example helps show the power of regular saving and compounding in hitting my monthly income goal.
But it presumes that share prices and dividend amounts remain flat over 30 years, which is unlikely. Both could go up — or down.
That helps explain why I would invest in a diversified range of dividend shares. That way, no one company cutting its dividend should have an outsized impact on my projected income. I would try to invest in companies I think are likely to see improving business returns over time. That way, hopefully they will not just maintain their dividends but may increase them.
I look for companies with a competitive advantage, resilient customer demand, and a business model that has proven itself profitable.
That has led me to dividend shares like Legal & General before now. Indeed, I would consider adding that share back into my income portfolio if I had spare money to invest. But like all firms it faces risks, such as a worsening economy hurting sales of its financial products. I think the risks are manageable — but they are a reminder of why I always keep my portfolio diversified.