Dividend Investing Makes Retirement Threshold Obvious

Dividend investors know exactly when they can retire.
Dividend investors know exactly when they can retire.

I’m sure it’s just coincidence, but I’ve come across a lot of “When do you know you’re ready to retire?” articles the last little while. — EDIT: Just this morning, Robb at Boomer and Echo has written a post on this very topic. — After reading a few of these, it struck me that I had never really considered the question of when I would reach my (financial) retirement threshold. It’s not just because retirement is so far away, or because I haven’t taken the time to make a specific goal. The reason is because, as a dividend investor, the answer is so obvious that almost no thought is needed.

The beauty of dividend investing is that income is produced every month. While this fact is painfully obvious, it seems to me that the benefits of this are not always fully appreciated. I’ll discuss more of these benefits at a later date, but the one I want to focus on today is that this income makes it perfectly clear when you have crossed the line, and are able to retire. (There are certain assumptions that need to be made, but this is true of any financial plan that looks decades into the future.)

In the simplest of terms, when your dividend income is greater than your expenses, you’re ready to retire. (Caveats to follow.)

One of the best reasons to invest in dividend-paying stocks is that they are generally slightly more than indexed to inflation. As such, once you reach a level of dividend income such that your dividends meet your financial needs, you are ready to live off them. In a perfect world, once you’re on the right side of the line, you’re home-free. Before you tell your boss to shove it, however, here are some factors to consider:

  • Your income needs to be from a well-diversified basket of stock (and perhaps royalty trusts). Putting too much faith in any single source of income is a recipe for disaster. While certain companies may seem like the Rock of Gibraltar right now, you plan on being retired a long time, and it is impossible to predict which companies will get side-swiped by new technology, scandal, lawsuits, or mismanagement. More than 5% of your income from any single course is asking for it.
  • Black Swan events and so-called “new normals” can take the carpet out from under you. Imagine if you had retired October 30, 2006. Many former income trust investors’ worlds were shattered on that day. Not only were tax-advantaged incomes devastated, so too was billions of dollars of capital as people rushed for the exits, selling income trust units at pennies on the dollar. Don’t bet against this kind of thing happening again. At a certain point, many years from now, the government is going to need some of the revenue that it is foregoing because of TFSA’s. If I were a betting man, I wouldn’t bet against TFSA’s being substantially re-jigged at some point in the next 50 years. Yes, that’s a long time, but that’s roughly how long I plan on living.
  • Unexpected expenses are, well, unexpected. People get sick. Husbands or wives become incapacitated. Children dig themselves into financial holes. New medical treatments are expensive, and not covered by provincial healthcare systems. Nobody needs to be told how divorces can wreak havoc on financial situations. You need to have some wiggle room in your finances, or risk becoming a burden on your family.

A major setback such as these (or many others) can change the retirement equation suddenly and drastically. (Of course, these would change any retirement plan, so these situations are not specific to dividend investors.) Retirement is meant to be a one-way street, so you want to be sure you don’t have to reverse course.

So, Mr. Doom’nGloom, what to do?

The simple fact of the matter is that stuff happens; try as we might, nobody has yet found a way to change that. The previous point about diversification and the other standard bits of sage investment advice still stand, but here is how I personally am planning on building in a margin of safety:

  • I will not consider my dividend income secure until it covers all of my living expenses AND allows me to re-invest 10-15% of my dividends yearly. This way, there is always new money going into my investments.
  • If at all possible, (and this point slightly contradicts the previous one) even when I have reached the above threshold,  plan on working at least another two or three years. This will give me a chance to actually live off of dividend income, to make sure that it’s actually possible, while still banking/investing 100% of my salary for this same time period. When you’re at the end of your career, (which usually means peak earnings) and are able to save everything that you are making, the savings pile up pretty quickly.
  • There is absolutely no way I will owe anybody any money for anything. (I hope that this will be the case years before I retire, but it absolutely must be the case before I leave the work force.)
  • In the “nice to have” category, I’d like to have developed a side income or two from completely different sources by then. This is simply another form of diversification.

Again, there are no guarantees in life (well, OK, death and taxes, but who wants to talk about those?). With these simple strategies, I hope to be in a position to enjoy my retirement, rather than be constantly fretting over money.

5 thoughts on “Dividend Investing Makes Retirement Threshold Obvious”

  1. I used to think this way, however I don’t think it’s realistic to live off dividends and never touch your capital in retirement. First of all, any RRSP savings will eventually be converted into an RRIF and face stiff withdrawal rates. Second, what if you want (or need) excess capital in one year to pay for a car, new roof, large vacation, etc.? You’d probably look to sell off some stock to access the capital. Finally, there’s the potential to work longer than needed in order to reach a target dividend income stream. It’d take a million dollars in capital to spin off $35,000 to $40,000 in dividends. Why wouldn’t you want to tap into that million dollars?

  2. I agree, Rob, a total return approach makes more sense. If I’m 100 years old, with a life expectancy of 2 years, why would I want to restrict my spending to $35,000 a year?

    Another point, if you do plan to retire and live off only dividends, you need a bigger safety margin than that. In the 1929 crash the dividend yield of the market dropped 50%. There is no guarantee a similar drop won’t happen again.

  3. I agree with Jeff’s original plan. I retired last year at age 60 without any company pension plan. My wife was a stay at home Mom so she has no CPP coming. I am already collecting CPP and combined with our dividend income, we can more than comfortably live off that income. In fact, we have a cushion of about 25-30k per year. (89k/yr total dividend income + 8.9k/yr CPP).

    We are almost 100% invested in Canadian dividend paying stocks and most of these are dividend growers (22 of 26 have had a dividend increase since Jan 1 2013). Because of our cushion, a dividend cut here or there is no problem. (although I would be very surprised if any of the companies we own cut there dividend).

    I also agree that a person has to be very careful with RRSPs for when they get converted to a RRIF and the automatic withdrawals. I did an analysis and decided it would be better to start withdrawing from our RRSPs by moving some securities to our TFSAs and non-registered accounts. It’s a juggling act with paying extra taxes now even though the cash is not needed versus waiting until RRIF time and potential clawbacks on the OAS and reduced old age deductions.

    I really like TFSAs and wish they had started earlier.

    Ciao

    1. Hi Don,

      Thanks for stopping by, and congratulations on your recent retirement. I hope it’s long, healthy, and financially comfortable!

      I guess my TFSA timing was as good as it could have gotten, because before they were introduced, I didn’t have any money to invest, anyway 🙂

      As soon as my children are old enough, I will be nagging them as hard as I can to always contribute the full amount to their TFSA’s every year. After a 40-year working life, those contributions alone should be enough to carry them quite a way, compounding dividend payments aside.

      Which (ironically) leads me to my biggest fear about TFSA’s, which is that at some point, when the government realizes how much revenue it is foregoing, the rules regarding them will change.

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