It’s helpful to have goals. It’s also helpful to figure out the steps to get to those goals. That’s equally true for dividend investing.
Let’s say you have a goal of paying all your bills with dividend income, building up enough capital that you can just live off the income. Unless you happen to come into a huge pile of money or have almost no bills, it’s likely you have a fair amount of work to do to reach that goal.
So let’s do some math, starting with some numbers that are less scary. Consider the following:
- You need $100 per month to pay your mobile phone bill (or essentially $1,200 per year).
- You’re probably going to need to pay taxes on that, so let’s assume you’ll buy a stock (or collection of stocks) that produce qualified dividends (i.e. taxes a rate of 15% compared to your regular income tax rate). So that means you need to produce about $1,400 per year to cover the taxes and your mobile phone bill. For this example, let’s ignore state or any other municipality rates.
- Let’s assume the stock has a 3% yield.
- That means you need about $46,700 in investment value to create $1,400 in dividend income on a 3% yield stock in order to have approximately $1,200 after (federal) taxes. I fully admit that’s a few extra dollars than I realized.
How did I do that?
- Annual income needed: $1,200 = pretax amount * (1-.15)
- Annual income needed = $1,200 / .85 = $1,412 (or $1,400 for round numbers)
- Annual income of $1,400 = investment amount * .03 yield
- Investment amount = $1,400 / .03 = $46,667
- While the original yield was 3%, after taxes that yield was more like 2.55%. Without taxes, the investment amount would have been $40,000.
But doesn’t a higher dividend stock produce more money?
Yes, but it depends on how many shares you have. A 3% yield is a 3% yield because the dividend price and share price pretty much cancel each other out in the math crunching.
What if the dividend is increased?
Dividend increases are great. If you’re in it for the dividend reinvestment, you’ll be increasing your holding by the yield percentage. Hopefully the dividend increase keeps the yield at the same level, or improves it, otherwise you’re potentially DRiPping at a lower rate per year. If you’re cashing out the dividend then you’ll notice that increase more so.
What if I find a stock with a higher yield?
You could potentially make that investment number less scary with a higher yield dividend, but two things to watch out for. In “regular” stocks, larger yields could be an indictor of issues leading to a dividend cut, because it may not be sustainable rate for the company. Or you’ve found a stock that doesn’t produce qualified dividends (such as a REIT or real estate investment trust). So the good news is that you would potentially be able to invest less to have a higher income, but you would need to achieve a larger income to cover the extra taxes.
To achieve a $1,200 after taxes income in an ordinary dividend stock, you would potentially need the investment to actually produce $1,600 per year to cover your mobile bill and the taxes (if your tax rate was approximately 25%).
For the following yields, that works out approximately the following investment amounts:
- 4% yield stock = $40,000
- 5% yield stock = $32,000
- 6% yield stock = $26,700
- 7% yield stock = $23,000
One other tip, if you’re buying an “ordinary dividend” stock in a taxable account make sure the investment amount makes sense. If you find an “ordinary dividend” stock paying a 3% yield and “qualified dividend” stock also paying 3%, you’ll have less income with the previous unless your regular federal tax rate is 15% or less.
And it would probably be less scary to start with a lower annual goal, such as $120 for the year or $10 per month. Time and patience are a virtue.