The article “Why Living Off Your Dividends In Retirement May Be A Mistake” was originally published on The Financial Post on May 14, 2015.
Many Canadians dream of amassing a retirement fortune that can carry them effortlessly through their golden years. It’s one thing to dream about it, but how do you actually do it? I warn you, it’s not for the faint of heart and it may be a bad idea anyway, especially if your goal is to live off your dividends.
Based on Statistics Canada’s 2013 Survey of Household Spending, Canadian households headed by someone over the age of 65 spend $53,709 on average. This includes $8,097 of income taxes, suggesting basic living expenses are about $45,612. Actual retirement spending can vary greatly, but this is a reasonable starting point.
In order to generate $53,709 of pre-tax income, you don’t have to rely on just the dividends from your retirement savings. The average Canada Pension Plan retirement pension is currently $7,673 and the Old Age Security pension is currently $6,765 if you’ve been a Canadian resident for most your life. These pensions are indexed to inflation.
Put another way, you have a $39,271 shortfall that needs to come from your investment portfolio if you aspire to live off your dividends.
In order to generate this dividend income, you’d need a portfolio of almost $1 million yielding four per cent in dividends. The exact math would vary depending on whether your savings were in a taxable or tax-sheltered account, but, suffice it to say, you’d likely need to be a millionaire. This is tough to aspire to for the average Canadian family, with their median income of $74,540.
But a dividend yield of three to four per cent on a retirement portfolio is not unrealistic.
For example, the S&P/TSX 60, which represents the 60 largest and most liquid stocks on the S&P/TSX Composite index, currently yields about 2.71 per cent in dividends. Of those 60 stocks, 17, including four of the big five Canadian banks, yield more than four per cent.
The media loves stories about people who have turned their modest Tax Free Savings Account contributions into a six-figure nest egg. But seeing as how the stock market is a zero-sum game, with as many winners as losers, the best most people can hope for is to be average and earn high single-digit stock-market returns over the long run.
As such, how to amass a million-dollar portfolio is no secret. The key to living off your dividends isn’t about gambling in the stock market and borrowing to leverage your investment portfolio. It’s about diligently saving and building a diversified, long-term nest egg.
If you’re saving for retirement now, keep in mind that a current retiree would need $1 million to live off the dividends using our assumptions above. If you’re 10 years from retirement, you probably need 22% more. Twenty years away? Try 49% more. And if you’re 35 years away, probably twice as much.
The increases are the impact of inflation. A million-dollar portfolio is likely the baseline now to live off your dividends, but it will keep on rising.
Of course, this quick math doesn’t take into account a home downsize, inheritance or a spending decrease in your later years and so on. It also doesn’t take into account that your dividends may or may not keep pace with inflation.
Stocks generally increase in value over time, beyond the dividends they pay. If you plan to live off your dividends exclusively, you may grow your capital during retirement, too.
Retirement planning is a personal decision, but you might be making a big mistake if you go out of your way to ensure you can live off your dividends, since you will be leaving a great deal of money when you die. In the process, you may have worked too hard at the expense of family time or spent too little at the expense of treating yourself.
Short-term saving and spending decisions are about balance, and long-term retirement budgeting is no different. Try not to save for tomorrow at the expense of today simply to become a millionaire.
You might just make the mistake of living off your dividends, being too wealthy and having your money outlive you.
Jason Heath is a fee-only Certified Financial Planner (CFP) and income tax professional for Objective Financial Partners Inc. in Toronto.