For most people, living off their investments sounds like a dream.
When they hear stories like Terra Heinz-Kerry earning $5 million a year through her investments in tax-free municipal bonds, they think thats only for the super rich. The truth is that it takes a decade or two (or maybe even a few generations) to achieve that sort of wealth. But with proper saving, planning and investing you (or maybe your kids) can live well of your investments.
So how much do you need to be able to live off your investments? The first step is to decide how much you need to live on. Lets suppose you need around $50,000 to pay your living expenses. Assuming that tax-free municipal bonds (or government treasuries) pay 5% per year, you’ll need a portfolio of $1million. Dollar Value of Portfolio = Required Dividend Amount / Dividend Yield of the Portfolio If you haven’t saved up a million dollars yet, this might seem like a far fetched scheme.
But if you start saving today and invest wisely, in a few years you’ll at least be supplementing your income. Eventually you should be able to retire in style. Even though I was broke after losing my shirt in the stock market crash of April 2000, today I’m getting over $750 every month in dividends! And I did it by consciously saving and investing my regular income. The key is to start and keep on going. You should also try to get more than the 5% (or less) that your bank’s saving account gives you. You should ideally try to get 12% return, since at 5% you’re barely beating inflation. This may not be possible every year, but should be for most. [Note: the average yield for the stock market is around 7-8%. It is not 11.8% as commonly mentioned. Source: Ben Stein’s excellent book Yes, You Can Time the Market]
One way is to invest in companies that pay a dividend and have historically kept increasing their dividend every year. Even though you might get only 2.5% return today, eventually with the increase in stock price and rise in dividends, your annual return should be greater than 12%. This concept is very well explained in Prof. Jeremy Siegel’s excellent book, The Future for Investors. Prof. Siegel, who’s faculty at Wharton Business school, proves through analysis of historical data that such companies like Philip Morris (now called Altria), Coke, Procter and Gamble, and Pepsi have provided much greater returns than the market or growth technology stocks, especially when the dividend is reinvested back into the stock. I strongly suggest checking out the book if you are serious about investing. Other alternatives are energy utilites and natural resource stocks, REITs and Canadian Income Trusts.
Investments in real estate can also yield 10-12% with potential for appreciation but these require a large investment (typically over $50,000). You also need to be aware of market cycles and might need to take an active role in the management. But with consistent earnings, savings and investing you should be able to live off your dividends. Don’t try to be greedy. Most schemes which promise 20%+ returns will eventually end up losing money. My personal rule of thumb is to get 4-5% more than what you can get in a 12 month CD. This should be fairly easy to achieve without much risk to principle. And always remember Buffett’s golden rule of investing: Don’t lose any money! Suggested Reading: