A lot of people ask me “how do you live off of your investments?”. I think that question is largely getting at the logistical nature of it. If you can build your portfolio up to $1M and beyond, how do you actually get the money out?
Well, it’s pretty simple! There’s two ways.
1. Dividends. When you own stocks, index funds, mutual funds, or ETFs, they (generally, depending on which ones) pay dividends! These are cash payments deposited directly to the account where you hold the investment. While you’re building your wealth, it’s good to turn ON the “reinvest dividends” checkbox in your brokerage account. But once you are living off your investments, uncheck that box, transfer the cash to your checking account and spend it on things that you like!
2. Selling some shares. MOST of the growth of the stock market, actually comes in increase in share price, not in dividends. That means, in order to live off your investments, you simply sell some shares each year, leaving the rest to grow for next year. Warren Buffet’s company, Berkshire Hathaway, has famously never paid a dividend. When some owners complained, he replies “if you want a dividend, sell 4% of your shares each year, leaving the rest to grow”. Berkshire Hathaway has been growing well over 10% per year so you can still grow your wealth, while enjoying the cash each year!
Note that this post is just an example. I don’t actually invest all of my money in the S&P 500. I prefer a more diversified approach, like a target date index fund (which pays even higher dividends!) It’s also not important to sell in January. I just listed a month because sometimes people get caught up on the details. Sell 3% once/year or one twelfth of that every month. Doesn’t matter much.
Also, some will ask about retirement accounts. These are fair game at 59.5, but there’s lots of ways to access wealth before that. A regular brokerage account plus many others.
As always, reminding you to build wealth by following the two PFC rules: 1.) Live below your means and 2.) Invest early and often.
-Jeremy
