Free Money

It is getting towards the end of the year, which means it is almost dividend time. To us this is essentially free money, as we don’t have to do anything in order to get it.

Dividends are typically paid out by companies as a way to distribute profits back to share holders and they are usually paid in quarters when companies make a profit. Most of our portfolio is in mutual funds, and of course all mutual funds are is just a collection of individual stocks, therefore mutual funds also pay out dividends.

For some reason mutual funds are typically back loaded so that the majority of dividends  come out in December. A typical mutual fund will pay around 2% in dividends, so if you have a portfolio that is large enough that you can live on 2% of the value then in theory you can live in perpetuity as you would be able to survive purely on the dividends. This is true financial freedom and is the holy grail of the FIRE movement.

We are currently living on about 2.7% of net worth, however net worth is not the same as our portfolio. Our net worth for example includes the value of our house, but of course our house doesn’t create dividends!

Realistically our dividends produce around 50% of our overall annual spend, meaning our draw down by selling investments is around 1.4%, a pretty conservative amount of spend.

Of course dividends are not guaranteed, some large companies don’t produce dividends, some very big ones such as Facebook and Alphabet (Google). Also if the economy is in a bad condition even reliable companies might decide to cut dividends. However large S&P 500 type companies try to avoid this as paying dividends is an incentive to lure in buyers and investors.

One other good thing about dividends is they are tax advantaged, as long as you have owned the stock for at least a couple of months before the dividend is paid then they are considered qualifying dividends which means they are taxed at the federal level at the capital gains rate which for most people will either be 0% or 15%, we should be comfortably in the 0% rate.

I don’t think we will ever get to the point where we can live purely off dividends (at least not until our pensions kick in) but if we can keep 50% of our approximate annual spend from dividends then I feel like we are in a pretty good shape.

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