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.