Retiring Off Dividends: What Are the Odds?

A Simulation of Retirement Dividend Income Using Varying Savings Rates and Time Horizons

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This is a guest contribution by Nick McCullum from Sure Dividend. Sure Dividend uses The 8 Rules of Dividend Investing to systematically identify high-quality dividend stocks suitable for long-term investment.

Investing in the stock market has historically been one of the best ways to build long-term wealth.

We can take this a step further — instead of just growing wealth, dividend stocks are one of the best ways to generate income.

In fact, the end goal of many dividend growth investors is to create a dividend stock portfolio (composed of ETFs or even individual stocks) that generates enough income to cover their retirement expenses.

With that in mind, this article investigates your chances of retiring off of dividend income using different savings rates and time horizons.

Some Benchmark Parameters & Assumptions

If you are investing in broad-based index ETFs (which is a great choice for the vast majority of investors), then the two most important factors in your long-term investment success are:

  1. Your savings rate
  2. Your time horizon

Because of the importance of these two metrics, they are the two main variables that I will tweak in this analysis.

More specifically, I will consider savings rates from 10%-50% (using incremental of 10%) and time horizons ranging from 45 year to 15 years (using 5 year increments). Using the traditional retirement age of 65, this implies a starting investment age of 20 to 50.

This analysis will estimate future investment returns by fitting a normal distribution through the historical returns of the S&P 500 Index ETF, which trades under the ticker SPY on the New York Stock Exchange.

SPY is a great investment option for long-term investors seeking broad-based equity exposure. In fact, Warren Buffett recommends a portfolio containing 90% SPY and 10% in short-term government bonds for the average U.S. investor with no financial experience.

Since 1993, SPY has had an average daily total return of 0.042% and an average daily total return standard deviation of 1.163%. I use daily returns (rather than monthly returns or annual returns) because this increases the sample size under consideration.

In reality, stock market returns do not perfectly fit the normal distribution; but it is a close enough proxy for the purpose of this analysis.

R was used to run a 1000-trial Monte Carlo simulation for each time horizon-savings rate pair. The R script that I’ve used to create the simulation is a variation of the Sure Dividend Retirement Calculator. You can see the modified script here.

I’ll also be assuming — for simplicity’s sake — that the person who is doing the investing has an annual income of $70,000 per year. This analysis would yield the same results for any other assumed income; but some level of income must be selected to compute the dollar value of invested capital given a particular savings rate.

The last assumption I’ll make is about dividend yield. The S&P 500 Index ETF currently has a dividend yield of about 1.9%.

This is certain to change over time; however, I have about as much information on what the S&P 500 yield will be in 15–45 years as I do about the weather in 15–45 years. In other words, I’m clueless.

One thing is certain: the S&P 500’s dividend yield is currently much lower than its normal historical levels:


Source: Multpl

This means that using its current 1.9% dividend yield as a proxy for future dividend income is conservative. Thus, 1.9% will be the rate used to determine dividend income once final portfolio values are computed using the Monte Carlo simulator.

The Simulation Results

Here are the retirement portfolio value after investing in the S&P 500 over various time horizons and savings rates using a $70,000 income for simplicity’s sake.


While this table is interesting, we do not care so much about portfolio size.

What we are really concerned about is our portfolio’s ability to generate retirement income.

The following table shows the retirement income generated from each of the portfolio sizes in the previous table, using the S&P 500’s current dividend yield of 1.9%. Cells highlighted in green are sufficient to replicate the investor’s annual employment income using dividends alone.


To generalize this, we can show — as a percent — the individual’s ability to replicate their day job income using dividend payments:


The retiree was unable to cover their retirement expenses using dividend payments in more than half of the situations I investigated. Importantly, there was no time horizon where a 10% savings rate was sufficient to retire on dividends alone.

So how can we make this easier?

There are a number of ways an investor can improve their chances. Aside from the obvious (starting earlier or increasing their savings rate), the retired investor can also invest in a high-yield dividend ETF (rather than the S&P 500 ETF).

One notable example is the Vanguard High Dividend Yield ETF, which trades under the ticker VYM. The ETF has a current dividend yield of 2.9%, significantly highly than SPY’s.

If an investor held SPY until retirement and then switched to VYM, the percentage of their employment income covered by dividend payments becomes far superior:


Under this scenario, an investor with a 30% savings rate and 30 year time horizon now has the potential to cover their living expenses with dividend payments. Moreover, a very long-term investor (45 year time horizon) with a 10% savings rate can now retire on dividends.

Importantly, there doesn’t appear to be any additional risks in this strategy; VYM has had almost exactly the same volatility as SPY since the inception of each ETF.

Investors who need even more yield can look for other investment options that offer the prospect of higher dividend income.


Final Thoughts

This article showed the impressive power of dividend growth stocks for long-term wealth creation.

With a sufficient savings rate and time horizon, investors stand a good chance of covering their entire living expenses on dividend payments alone.

For the scenarios where dividends were not sufficient, the outlook is not necessarily bleak. It is alright to draw down some principal during retirement if you do not intend to pass on your full wealth to your heirs. Many people enjoy long and prosperous retirements by periodically selling some of their stock holdings.

With that said, the best case scenario is to retire on dividends alone. This article showed that this is a distinct possibility using a long-term dividend growth investing strategy.

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