Back in 2015, I had a passive income earnings stream of £0. The only money that was in my bank account was from my paycheque working 9 – 5. I knew I couldn’t go on like this. I knew I didn’t want to work this job forever. I knew I had to escape the rat race. In order to do so, I had to create a plan. I needed to be an owner of cash generative assets. And that is when I started to create my second source of income via dividend shares.
I started saving a large portion of my income every month, and investing it wisely. My savings rate has consistently been above 50%. Rather than just leave that saving in cash earning a paltry rate in the bank, I decided to make my money work hard for me. I decided to invest that money in top global blue chip companies such as BP, Coca Cola, GSK and Unilever.
In return for having an ownership stake in these companies, I receive my share of the profits in the form of dividends. As these companies continue to grow their profits, so does my dividends payments. And the best companies are amazing at growing their profits and dividends year after year no matter the macroeconomic situation.
Coca Cola for instance has raised its dividend for 55 years straight. Isn’t that amazing. It means that over the last half a century, when we have faced multiple wars, recessions, natural disasters, market crashes, financial crises and a depression scale meltdown, Coca Cola continued to earn profits and grow their dividends. If this isn’t an example of a resilient quality company I don’t know what is.
Over the past three years, I have been building my portfolio around companies that possess economic characteristics similar to that of the coca cola company. And all these companies, bar one or two, have been paying me a growing dividend year on year. It certainly does pay to be a part owner of the best businesses in the world.
Right now, my expected annual dividend income from my portfolio of companies is scheduled to cross £2,500 for the first time ever. This number is calculated by multiplying the current annual dividend per share on each investment I own, times the number of shares I own. The best part is that this income is generated in a tax free ISA account. In other words, if I do not add any new cash to my investment accounts, and I do not reinvest dividends, I will be able to generate £2,500 in tax free annual dividend income going forward. And this figure is only set to grow as the dividend income companies I own continue to grow.
Regular readers will know that my annual dividend income has been increasing over the past three years. This is due to dividend growth from the companies I own, reinvestment of dividend income, and from new capital that is put to work.
Truth be told, I could have had a higher annual dividend income figure in the range of £3,500 – £4,000 a year. But I have been investing a portion of my portfolio in low dividend paying (low yielding) companies such as Visa. The idea is that since these companies have a low yield and a very low pay out ratio, they will continue to have above average dividend growth figures in the years to come. And since I am only in my mid-twenties, I can afford to be patient with a certain section of my portfolio. I am sure companies like Visa will be one of my highest yielding in years to come.
When I look at my portfolio, I essentially have three categories of shares.
- The First category includes low growth but high yielding shares. Examples include SSE and Vodafone.
- The Second category includes companies that are in the sweet spot of moderate yields and moderate dividend growth. Examples include Unilever and Britvic.
- The Third category includes companies with low current yields but high expectation for dividend growth. Examples include Visa and AG Barr.
A second reason why my dividend income is lower than it could be is that a good portion of my portfolio is still in cash. I am a conservative and prudent investor by nature. This means that I am not tempted to buy any old junk. I don’t want to own high dividend paying shares for the sake of boosting my dividend income.
Normally, these shares are high yielding for a reason – the market is pricing in a dividend cut. Yes there may be times you can get safe high yielding shares. Examples are me buying into BP shares at a 8% yield and Royal Dutch Shell shares at a 9% yield. But these offers do not come often so if you are sure that a dividend is safe, you need to strike.
I want to own shares in quality companies that can grow their dividends over time. So I am very cautious in my investment decisions in this regard.
But one thing I will say is that the next £2,500 will be attained quicker than the last £2,500.
Firstly, it is because dividend growth works better on bigger figures. If you own shares in Company A and expect to receive £100 a year, a 10% increase will mean you’re new dividend income is £110 or £10 more. But if on the other hand you expected to receive £300 from a company, that same 10% increase will give you £330 in annual dividend income – or £30 more. It’s the law of bigger numbers.
Another reason why the next £2,500 will be easier to attain than the last is because my dividends are now buying more dividends. I now have a fresh £2,500 hitting my account every year to invest as I please. With this added capital, I can turbo charge my dividend income.
The ability to generate more cashflow from existing dividends is not widely understood by most people. The more I invest, the more my income is increased. Let’s see what this means in a scenario where a single person earns the UK average £30,000/year, and saves £15,000/year.
Let’s assume that this money is invested in a portfolio of dividend paying stocks yielding 5%, that grow dividends at say 5% a year on average. Let’s assume that in year two, the person is still paid £30,000 and they manage to save £15,000 a year. However, the person would also earn £750 in dividend income from the dividend seed that was planted in year one. This increases the total amount available for investment to £15,750. If this amount is further invested, the amount available to invest in year three would be £16,537. In years four, five, six and seven, those figures would have increased to £17,363, £18,231, £19,142, £20,099. All of a sudden, you have just over £5,000 in free money to invest.
The Dream Is To Live Off Dividend Income
So what’s the purpose of all the dividend income. Is there an end goal? Yes, there certainly is. The idea is to create enough passive income in order to cover my expenses and ‘retire’ young. The reason I put quotations around the word retire is because I am not quite positive I’ll retire by standard definitions. I think the best phrase to use might be ‘I want to be financially independent in my mid-30s’.
I largely want a choice in how I spend the majority of my time. And that is exactly what my dividend income will provide. If I don’t have to worry about money, I can chose to do whatever I want.