Published July 26th, 2015
We’ve all heard that money can’t buy happiness. That is only half-true. Money can’t buy unlimited happiness, but a higher income does make us happier (on average) up to a point.
A famous study found that rising personal income does make us happier, but only up to an income of $75,000 a year.
Time & Money
One of the principles of finance is that money in the future is worth less than money today. This has been known since at least 620 B.C., when Aesop wrote that “a bird in the hand is worth two in the bush”.
Time is valuable. I argue that someone who spends 1 hour a week making $75,000 a year will likely be happier (all other things being equal) than someone who spends 80 hours a week to make $75,000 a year.
The reason is you get to spend time doing what you want, rather than what you have to. Of course, there are exceptions. If you absolutely love your job (like I do), then working is what you want to do.
The income goal for ‘happiness maximizers’ – which should be all of us– is to generate $75,000 (or more) a year in passive income (or doing what you absolutely love).
How do you generate $75,000 a year in passive income? With dividend growth stocks.
How Long Does it Take?
A portfolio with a 3% dividend yield has to have a value of $2.5 million to generate $75,000 a year in passive income.
With a portfolio this size, you can comfortably live off of dividends alone without ever having to sell any stocks. Your portfolio of dividend growth stocks will very likely continue to pay rising dividends, so you actually receive more money every year.
With a portfolio this size, you create intergenerational wealth. Your children and children’s children will be able to live off of the dividend income, just as you have (assuming no one sells any stocks).
$2.5 million is A LOT of money. The easiest way to gain $2.5 million is to inherit $5 million and blow half of it in Vegas. All joking aside, it typically takes a lifetime to generate this much wealth. Exact time calculations and estimates are below.
The Dividend Aristocrats Index has returned 10.6% a year over the last decade. A reasonable growth estimate for a dividend growth portfolio (with dividends reinvested) is around 9% a year.
Returns could well be higher, but 9% is a reasonable long-term target growth rate. After inflation, total returns should average around 7% a year.
If you generate total real (after inflation) returns of 7% a year and save $500 a month, it would take nearly 50 years to reach the required $2.5 million portfolio. Saving $1,000 a month cuts the time to about 40 years… Starting with $100,000 and saving $1,000 a month cuts the time to under 34 years.
A Quicker Path
There are no shortcuts in investing. Get-rich-quick schemes work… For the person selling them, but not the buyers. There is no substitute for time, consistency, and safety in investing.
With that said, you don’t necessarily need a portfolio of $2.5 million to generate $75,000 a year in passive income.
The reason is simple. No one lives forever. Let’s assume everyone lives to 120 years of age. Even those who don’t like to face their own mortality will likely admit that living to 120 would be quite the longevity accomplishment.
If you are currently 55, plan to withdraw $75,000 a year from your retirement account, earn after-inflation returns of 7% a year, and expect to live to 120 years of age, you will need just under $1.1 million. For a 65 year old with the same expectations, the amount needed is just under $1.08 million.
For older investors with less than this saved, don’t panic. Social security and other sources of income should help bridge the gap. Additionally, one can always live on less than $75,000 a year.
Obviously, these are still large numbers, but they are attainable, especially for younger investors. If you save $1,000 a month and generate 7% after-inflation returns a year, you will have $1.1 million in under 30 years.
Excel Spreadsheet Download
Click this link to download an Excel Spreadsheet that calculates how long it will take to reach a certain savings goal, and/or whether you have enough savings to live on for the remainder of your time.
The ‘Accumulation Phase’ tab in the spreadsheet is for finding the time it will take to reach a savings goal. The ‘Distribution Phase’ tab in the spreadsheet is for finding the amount of time your portfolio will last given a certain monthly distribution amount.
It is important to note that this spreadsheet only provide estimates. It is not investment advice. The spreadsheet does not factor in volatility. Volatility in markets effects investors in the distribution phase, because you may be forced to sell stock when markets are down to support your lifestyle.
Independence, Freedom, & Luck
In my mind, the ultimate goal of dividend growth investing is to generate enough passive income to cover all your living expenses.
When you make enough passive income to support your lifestyle, you are free to do whatever you want. You have gained independence from having to do anything.
According to Daniel Kahneman, having income of $75,000 a year is the minimum amount required to maximize happiness from income. This number is a good passive income goal for younger dividend growth investors to shoot for.
We can all strive to save and invest with a plan. By doing so, we minimize the uncertainty surrounding our future, gain independence, and live life on our own terms.
“So use all that is called Fortune. Most men gamble with her, and gain all, and lose all, as her wheel rolls. But do thou leave as unlawful these winnings, and deal with Cause and Effect, the chancellors of God. In the Will work and acquire, and thou hast chained the wheel of Chance, and shalt sit hereafter out of fear from her rotations.”
– excerpt from Self-Reliance by Ralph Waldo Emerson