Many Canadians are interested in the idea of quitting work early to live off dividend and investment income. While retiring early is an exciting concept, it is becoming more and more challenging to execute. The cost of living across Canada has drastically increased in recent years.
The ability to retire early depends on a mix of variable factors such as: your salary, your standard of living, your level of debt, where you live, your capacity to save, and your ability to invest wisely.
As a result, there is no one right answer on how much cash you would need to live off dividend income. It really depends.
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The average Canadian needs around $6,500/month
The median family income in Canada is $98,400. That equates to about $8,200 of gross income per month. After tax, that is probably closer to $6,500 per month (or $78,000 per annum). Certainly, this is not a massive amount to live from.
However, given it is a median income, many Canadians are living within these means. With some frugality and modesty, a near-retirement couple could have a comfortable lifestyle on that level of income (especially if they will soon start to collect their CPP retirement pension).
Now that we have established a required dividend income of $6,500 per month, we need to understand what sort of investment options are available. We will have to work backwards a little bit.
How much cash do you need to earn $6,500/month of dividend income?
The iShares Core S&P/TSX Capped Composite Index ETF (TSX: XIC) (an index that mirrors the TSX stock market) has a 12-month trailing dividend yield of 2.82%. If you divide our required annual income ($78,000) by the ETF yield (2.82%), you will need $2.8 million invested to earn $6,500 per month.
Now, if you were looking for a more income-focused index, you could choose the iShares S&P/TSX Composite High Dividend Index ETF (TSX: XEI). It has a trailing yield of 5.18%. Complete the same exercise and you find you will need to invest $1.5 million to earn the same monthly income.
Indexes are good, but you can get better total returns by growing your own investment portfolio
Index investing is a great way for people to invest without having to get too involved. However, you don’t get to stack a portfolio with the highest quality businesses. You just own everything in the index (both good and bad).
The TSX Index and the TSX High Dividend Index have only delivered respective average annual capital returns of 4.5% and 0.7% over the past 10 years.
You can do considerably better by building your own income portfolio. It will take investment acumen to earn income and grow your capital. Likewise, you may have to sacrifice yield to own better quality businesses.
CNR is a good stock for total dividends and capital returns
For example, Canadian National Railway (TSX: CNR) only yields around 2%. However, it has increased its annual dividend for 20 consecutive years. Its dividend has grown by a 15% compounded annual rate.
The company has an essential transport network that spans North America. It consistently generates strong returns on its invested capital. Not only has it paid considerable growing dividends, but shareholders have earned a 750% capital return over the past two decades.
CNR has delivered a strong ~14% annualized total return for shareholders over the years. If you had annually reaped your total gains (around 14%), you would have only needed to invest $560,000 to hit an average annual income of $78,000 per year.
The point is, look at earning income in terms of total returns (not just dividend income). Capital gains are an important income factor in the portfolio mix. You don’t want to sacrifice one in place of the other.
