My dad and I had a conversation about what we’d do with $500,000. From his perspective, he’s into the real estate investing venture and told me that he’d probably buy properties and rent out the rooms for passive cash flow. A cheap, yet decent home within the DC area is around $500,000. However, from an investing perspective, I started thinking about what sort of dividend investing strategy to use. I believe a strong dividend investing strategy will grant financial independence.
For example, for a low risk, extremely passive approach, you stick $500,000 into a bank account and earn interest on it. FDIC protects the money. And in a savings account with 2% interest a year, that’s $10,100.39 in interest. (Interest Calculator)
What About a Dividend Investing Strategy?
However, what if it was deposited into a portfolio account invested in dividends? It’s passive and low risk enough compared to stocks, and dividends tend to bring in higher gains than a simple savings account.
For example, let’s pretend we have SDY. SDY is an ETF of Dividends. SDY is an actively managed fund. This is because of the manager frequently re-balancing and changing the portfolio to meet its objectives.. Because of this, investors in SDY pay an annual expense ratio. SDY gives us an annual yield of 2.82% in dividends (in 2015) and has an expense ratio of 0.35%.
To implement our dividend investing strategy, we stick $500,000 into SDY. Of course, in the real world, remember to diversify your portfolio. Once we stick $500,000 into SDY, then we determine our returns would be $14,100 before expenses. This comes down to $1,175 per month. Again, before expenses.
In the scenario using dividends on the SDY, we’re getting up to $14,100 over the course of the year. Unfortunately, the downside to SDY is the high expense ratio. This eats up a chunk of our returns. Ultimately, the optimal thing to do is to pick individual dividend stocks for your dividend investing strategy to eliminate the expense ratio.
If we were to do an apples-to-apples comparison, we could say the expense ratio is analogous to rental property expenses. In the dividend investing strategy, there’s a small fee to pay to manage the portfolio. Just like how there’s a small fee to pay for managing property.
What About Taxes?
If you incorporate and rent out your property, you’ll be taxed as a business. According to tax laws, you’d be taxed at 15%. However, this assumes that you only have one property. Taxes can go into higher brackets if you have more properties and more rental income. Additionally, you need to pay property taxes once per year. The average property tax was around 1%
For the dividend investing strategy, you will only ever be taxed at 15% maximum. It doesn’t matter if you have 1 stock or 1,000 stocks. The maximum you pay, assuming the dividends are qualified, is 15%.
Why I Pick A Dividend Investing Strategy Over Real Estate?
A dividend investing strategy has the advantage of liquidity and easy management. In addition, rental properties require work. The initial capital requirements are low. And dividends won’t bother you if your faucet is broken.
With $500,000, we have the potential to make $14k per year in dividends. If we were to expand our $500,000 to $1,000,000, we can see our annual passive income go from $14,000 to $28,000. Additionally, if we were to pick individual stocks, we can eliminate expenses.
If our lifestyle and expenses have necessitated an annual income of $80k per year in order to live comfortably, then in order to achieve financial independence through dividends, one would need a portfolio of around $2.5 Million! Fortunately, this only assumes we invest in SDY. If we build our own, it may provide higher yields.
Achievable? Absolutely! However, it takes extreme discipline. Don’t buy overpriced stocks. Sometimes it’s best to wait for a good price or a dip. Although, the busy investor will purchase a fund and stick with it.
In conclusion, we aim for the ultimate goal: Financial Freedom. As we increase our capital, we increase our annual passive income. Ultimately, we’ll be spending most of our money on the dividend investing strategy. This will continue to build more assets. And the assets will build more passive income. Passive income grants us financial freedom.