Living Off Dividends: Myths And Facts

Hemant Rustagi
Chief Executive Officer, Wiseinvest Pvt Ltd.

Many investors often wonder if it is possible to live off dividend income. Living off dividends using dividend income is an alternative to take out money from your portfolio. Knowing how to live off dividends successfully means finding the right balance between income generated by your investments and the rate at which you spend that income. If you are someone who wants to explore this idea, you must do it after considering the related pros and cons. Of course, to implement this strategy, you must have a lump sum to invest.

Remember, there are two ways to get dividend income: dividend from stocks and dividend from mutual funds in your portfolio. Dividends are a portion of earnings that companies choose to distribute to their shareholders rather than reinvest in the business. Since the companies make the decision of how much dividend will be paid, as a shareholder you don’t have any say on both i.e. the quantum of dividend and the frequency at which it is paid out. Besides, the dividend yield is very low in case of growth companies. 

Dividend yield tells you how much a company pays out in dividends relative to its stock price. No doubt, by choosing to invest in high dividend-yielding companies i.e. companies that have mature businesses and have the ability to generate cash on a sustainable basis, you can improve dividend yield. However, there will be a compromise on capital appreciation. Another way to get divided is from your mutual fund investment. In case you decide to opt for this option, you need to let the fund house know of your intention by choosing the option ‘Income Distribution cum Capital Withdrawal’. 

Here too, the fund decides the frequency as well as the quantum of dividend. However, the dividend yield is usually higher than stocks based on the type of funds you invest in. If your portfolio has a combination of stocks and MFs, you need to assume an average dividend yield and based on that work out how large your portfolio should be. For example, if the average dividends’ yield of the combined portfolio is 5 per cent and the requirement is to generate an annual income of Rs 6 lakhs i.e. Rs 50,000 per month, the minimum portfolio size has to be around Rs 1.20 crore.

Considering that the dividend amount can vary almost every year, some kind of cushion has to be provided either by investing additional amount or creating an emergency reserve for this purpose. Now that you know how you can earn dividend on your investments, an important aspect that will determine whether dividend is sufficient enough for you to live off it or not is taxation on dividend. Dividend income is added to your income and taxed at the applicable tax rate. Therefore, for investors in higher tax slabs, it can result in a much larger tax outgo and a substantial increase in the requirement of dividend income through a larger corpus.

This corpus should be enough to cover expenses as well as take care of inflation over the years. Living off dividend income sounds nice but there are challenges. A strategy that can ensure sufficient regular income and provide an opportunity to make your money grow is to opt for a systematic withdrawal plan (SWP). Here, the fund redeems units worth a fixed amount, as determined by you, and transfers the money into your bank account on a pre-fixed date at a pre-decided frequency. It is a strategy that can tackle the issue of regularity in income, both in terms of the quantum as well as the taxation given that the tax incidence can be much lower for investors in higher tax slabs.