Can I Rely on Dividends for Life After Quitting My Job?

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Imagine doing the things you love without worrying about money. That's the dream for many Americans. Some achieve this goal in their 60s when they retire. Others can do it even earlier.

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One of the top ways people fulfill this dream is by investing in dividend stocks. But can you rely on dividends for life after quitting your job?

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How could you live off dividends for life?

The concept of living off dividends for life is a simple one. First, you invest a sum of money in stocks that pay dividends. Second, you use the dividend income to cover your expenses after you quit working. Easy-peasy? Not necessarily.

First, you'll need a substantial amount of money to invest. Exactly how much depends on the dividend yield the stocks you invest in pay. The dividend yield is the annual dividends per share paid by a company divided by its current share price.

Divide the amount of annual income you require by the dividend yield you expect to make to calculate how much money you'll need to invest. For example, let's say you want to make $100,000 per year. If you receive a dividend yield of 3%, you'll need to invest around $3.33 million ($100,000 divided by 3%) to get that amount. That amount is attainable for some, but it could be a stretch for many people.

If you want to retire on dividend income but don't have $3.33 million to invest, you have two options. First, you could try to get a higher dividend yield. A dividend yield of 5%, for example, would require only $2 million invested to make $100,000 per year. Second, you could try to live on less money. If you could make ends meet on $70,000, you'd need $2.33 million to invest with a 3% dividend yield.

Risks to consider

There are some risks to keep in mind, though. One biggie is that the dividend yield you receive in the future might not be as high as the yield you get at first.

Some companies cut their dividend payments over time. A few even suspend or eliminate their dividend programs. For example, going into 2020, The Walt Disney Company had paid a dividend for over 40 years. As a result of the COVID-19 pandemic, the company suspended its dividend program for three years.

It's also possible that a company that has reliably paid dividends for a long time will be acquired, resulting in the elimination of its dividend. Walgreens Boots Alliance is a great case in point. The pharmacy giant had a streak of 47 consecutive years of dividend increases as of late 2023. However, Walgreens cut its dividend in January 2024. It's now in the process of being acquired and taken private.

Inflation is arguably an even greater threat. It can erode the buying power of your dividend income even if none of the stocks you own reduce or suspend their dividends.

Potential strategies

The good news is that there are potential strategies you can follow to minimize these risks. Probably the most important one is to diversify your investments. If you only own five stocks, and one suspends its dividend, your income would be reduced by 20% assuming they are all paying the same amount. But if you own 25 stocks and it happens, your income would be only 4% lower.

Investing in dividend-focused exchange-traded funds (ETFs) is a great way to diversify. For example, the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) owns 103 dividend stocks. Its top holdings include Coca-Cola, Verizon Communications, Altria Group, Cisco Systems, and Lockheed Martin.

The Schwab U.S. Dividend Equity ETF currently offers a dividend yield of around 4%. This ETF has also delivered an average annual return of roughly 12% since its inception in October 2011.

If you want diversification and an even higher yield, closed-end funds (CEFs) could be an alternative. One CEF that I own is the Cohen & Steers Infrastructure Fund (NYSE: UTF). This fund owns 259 stocks. Its distribution yield is a lofty 7.2%. The CEF's average annual total return since its inception in March 2004 is 9.5%.

There are two key things to note about closed-end funds, though. Many of them use leverage (borrowing), which increases their risk. The Cohen & Steers Infrastructure Fund's leverage ratio is 28.5%. Their fees are also typically higher than ETFs.

How can you minimize inflation risk? Look at the history of dividend increases for the companies and funds you're considering. Just because a company or fund has increased its dividend consistently at an average rate higher than inflation doesn't mean it will always do so. However, investing in stocks and funds with strong track records of dividend hikes could increase the odds that your annual dividend income at least keeps up with inflation.

Finally, reevaluate your holdings regularly. The stocks and funds that are great picks today might not be such great picks a few years from now. Many Americans can quit their jobs and rely on dividends for life. But the sources of those dividends could need to change from time to time.

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Keith Speights has positions in Cohen & Steers Infrastructure Fund and Verizon Communications. The Motley Fool has positions in and recommends Cisco Systems and Walt Disney. The Motley Fool recommends Lockheed Martin and Verizon Communications. The Motley Fool has a disclosure policy.