It’s every stock market investor’s dream to generate enough money to quit their job and live off the passive income from their dividends. Even if they don’t actually want to stop working, it’s nice to have the choice.
Like most grand ambitions, it can’t be done overnight. Building a big enough portfolio to generate a decent level of retirement income is the work of decades for most of us. So the earlier we start, the better.
Even if we don’t earn enough money to retire early, at least we should enjoy a decent level of comfort when we finally stop working.
The FTSE 100 is the arguably the world’s best stock market for passive income. Currently, the index yields 3.6%, which is forecast to hit 4.2% this year. By comparison, the S&P 500 yields just 1.69%.
I’m on the hunt for dividends
In practice, I’d aim to generate a much higher income than that, by targeting stocks at the higher yielding end of the scale. A dozen FTSE 100 stocks currently yield 7% a year, or more, including three I recently bought, mining giant Rio Tinto (7.75%), insurer Legal & General Group (8.27%) and fund manager M&G (9.56%).
First, I need to decide how much income I’d like. There’s no point retiring early then living on a pittance for 30 years, or more, so I’d aim for £37,300 a year. That’s the amount a single person requires to ensure a ‘comfortable’ retirement, according to calculations by the Pensions and Lifetime Savings Association.
So how big a portfolio do I need to generate that? I’m going to use an assumption called the safe withdrawal rate, which states that if someone takes 4% of their savings each year, their pot will never run dry.
Aiming a little lower
To generate £37,300 I would need £932,500 of total retirement savings. That’s a tall order and, sadly, I’m nowhere near ISA and pension millionaire status. These things take time.
Alternatively, if my FTSE 100 portfolio yielded 7% and I took all my dividends as income, I could generate my passive income target with £532,857. The danger is that the capital value would erode over time, unless stock markets grow healthily. Also, dividends aren’t guaranteed, and can be cut, or scrapped, at any time.
Clearly, there’s a reason why in the UK many people carry on working if they’re well enough to do so, and if I wait until State Pension age things suddenly look a lot more promising.
The new State Pension currently pays a maximum £10,600, so I would only need to generate income of £26,700 to hit that £37,300 target. For that, I would need £667,500 in my portfolio, assuming a 4% withdrawal rate, or £381,429 if I lived off my 7% dividend yield.
Despite the popularity of the Financial Independence Retire Early (FIRE) movement, my figures suggest we won’t all achieve our target amount. Yet we could get close and we’d all be better off for giving it a shot. That’s what I’m going to do.
