I’m fortunate in that my portfolio generates a strong dividend income. But by no means is it enough to live off. As a rough calculation, I believe I need somewhere in the region of £30,000 in tax-free dividends every year if I want to quit work.
So is this something I could feasibly achieve?
Building a portfolio
Of course, we can’t generate £30,000 in dividend income unless we’ve got a sizeable portfolio and we’ve invested in dividend stocks paying a strong yield. The challenge is, for many of us at least, building that portfolio.
This is laid bare when we see that the average person in the UK has just £17,365 in savings. Moreover, 34% of adults had either no savings, or less than £1,000 set aside.
With £17k invested in stocks average a 5% yield, an investor could only hope to receive around £850 a year in passive income. Clearly, that’s not enough to live off.
Instead, to generate £30,000 in passive income, I’m going to need at least £400,000 invested. And this money would need to be invested in stock with 8% yields — right now there’s a handful of them.
Turning £17k — that average person’s savings — into £400,000 isn’t easy, but it’s possible. According to my calculations, using a compound returns strategy, and a monthly contribution of £400, I could reach my target in 19 years.
Expediting the process
There are several components to this process. Namely, the starting capital, the monthly contribution, and the growth rate. Collectively, these factors influence how long it will take me to reach £400,000.
This calculation assumes I can actualise 10% growth year on year, much of which I’ll want in dividends to allow me to practice the compounding strategy.
This figure, 10%, is actually less than the annualised growth rate of the FTSE 250 in recent years. So one way to expedite the process is by aiming for a higher growth rate, say 12%. This is possible, and it’s what I’m looking to achieve year on year, using undervalued, dividend-paying stocks like Lloyds and Legal & General.
Of course, another way to expedite the process is to contribute more money on a monthly basis. Firstly, contributing monthly is a sensible strategy as it allows us to smooth out the peaks and troughs of the market.
Naturally, £400 a month might already be a lot for some investors, especially after tax, rent, and pension contributions. But we could look to increase our contributions by 5% every year — that might be in line with salary growth.
By increasing our contributions by 5% a year, and actualised 12% growth annually, we could hit £400,000 in 16 years.
However, I do need to realise that even the best investing strategy isn’t guaranteed to bring results, and I could lose money, especially if I pick my stocks poorly.
And finally, I’m going to want to make these investments within an ISA wrapper. That’s because it would allow us to take our dividends without being taxed.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
The post How I could quit work and live off dividend income alone! appeared first on The Motley Fool UK.
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James Fox has positions in Legal & General Group Plc, and Lloyds Banking Group Plc. The Motley Fool UK has recommended Lloyds Banking Group Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
