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Is it possible to build a passive income and live independently purely through dividends? This article will answer

Jamie Cameron
23. 10. 2022
7 min read

To do whatever one likes, to travel, to have fun, not to work and still not worry about money? This is the dream of many people. And it can be achieved, for example, by investing and dividends. In this article, we'll look at all the things it entails!

Your investments can earn and grow without much intervention

Passive income is the dream of many people - often not even investors yet. The idea of "lounging on the beach" and making money is a nice one. So let's leave aside the fact that I'd probably go crazy doing nothing and let's look at what it would take to get there. I will need mainly time and compound interest. We'll explain this using the example of the world's most famous index.

The average return of the S&P 500 index from its inception in 1928 to the end of 2021 was about 11.8%. There were many ups and downs during this period. Sometimes these movements have been quite drastic, such as during the oil crisis in the 1970s or, closer to the present, during the global financial crisis of 2007-2008.

Even the chart, which does not go back to the origins of the index, looks absolutely monstrous

Going forward, however, most economists and professional investors expect stock returns in developed markets, not just the US, to decline. More or less the point is that the companies in the index may be the best, but they simply will have nowhere to grow. The planet is not inflatable. But this is just speculation. That is why, in many opinions, it is not pragmatic to expect an annual return that reflects the past. Most research suggests that investors should expect more like 7%. We reinvest dividends, the experts are unnecessarily skeptical, so let's say 9% 🙂 .

But I'll still be pretty drastic and use this lower interest rate - unlike some fanatical passive income fans who model their calculations with values that would easily beat the market and put more than one top hedge fund manager to shame. But maybe the index will surprise and prove its historical strength.

Such a return is therefore probably quite realistic and achievable. I'm going to assume that I want to build passive income and "enjoy it a bit" before I retire and set my horizon at twenty years. With a fairly realistic investment of 3000 crowns per month, I will save just under 1.7 million crowns. In the case of the index, we are talking about a dividend yield of about 1.8%. For the sake of simplicity, let's calculate that we will only start drawing dividends on this final amount. This gives us roughly 30 000 per year. That is not a lot.

With a 20-year horizon and an interest rate of around 9%, we'll save 1.7 million

So we need to push on one of the variables in the inverse money/time relationship. We can wait, say, thirty years for passive income. At thirty years, the exponential is already starting to work and we will have saved 4.1 million. But the dividend will still only give us 73,000 a year. So we are nowhere near the average monthly salary.

A horizon of 30 years at a still reasonable interest rate

So let's try it the other way around. Push on the other side of the scales - in the amount invested. With an investment of ten thousand a month (I understand that this may seem like a lot to some - on the other hand, it is not yet a completely staggering amount), the initial catalysis is already quite solid and we will save 5.6 million over 20 years. That is, roughly 100,000 crowns per year. That can be a nice bonus to the classic income. But it's hard to reckon that one could stop working forever.

This is where we get into the interesting numbers

Unfortunately, it comes down to the answer that everyone has probably already kind of guessed. If I want to achieve passive income in a reasonable time frame, then I have to invest a lot. In order to talk about an income that is probably livable, we need to invest roughly 30,000 a month for 20 years. In that case, we will have roughly 17 million and 300,000 a year in dividends. Of course, if we neglect inflation and other influences that will affect this amount over the next 20 years...

But there is another option - to opt for higher yielding investments. But we still have to keep in mind the basic lesson - higher return = higher risk (and I certainly don't want to say that the SAP500 index example is risk-free, no one will guarantee you anything). I won't even go into more details, which everyone should study on their own. These investments already take a lot of knowledge and skill.

You can find stocks that have a reputation among investors for being quite reasonable and stable dividend titles. Typically, $KO+0.4% and its ilk have a stable dividend of around 3-4%, in which case the amount invested to achieve passive income would be reduced rapidly.

Of course, pieces with double-digit dividend yields, for example, also look appealing, which can look extremely good indeed. However, it is rarely sustainable and pays out in the long term. So definitely watch out for that. This can come in handy for investors who are investing more actively and may dispose of the company early.

Also, watch out for the stock itself. A nice dividend is great. But the company that pays it also needs to be in good shape. When the share price drops drastically, even a fat dividend won't help.

These are just extremely simplistic and truncated calculations and values that are only meant to illustrate the situation. I have not taken into account investment methods that can yield higher appreciation than the most common and widely used index. I have also neglected the fact that, in addition to the dividend, we are also left with a solid sum of money in the form of the amount invested. We may (and may not) start to draw that down as well.

The entire article serves as an illustration and answer to the question of whether one can build passive income in the form of dividends. The answer is YES. However, you will need either a really big amount of money, a lot of time, or a huge amount of skill and a good dose of luck to help you progress faster. But of course, you don't have to build passive income with dividends alone. You can choose, for example, the path of growth stocks and their gradual divestment, entrepreneurship, etc.

I hope the article has given at least a little idea to beginners who are thinking about this path and has not offended seasoned investors with its simplification 😁

What about you? Are you trying to build a passive income? Is that your path, or are you not interested in this issue at all?

If you enjoy my articles and posts, feel free to throw a follow. Thanks! 🔥

Disclaimer: This is in no way an investment recommendation. This is purely my summary and analysis based on data from the internet and a few other analyses. Investing in the financial markets is risky and everyone should invest based on their own decisions. I am just an amateur sharing my opinions.

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