When I question whether something is sustainable I think of whether “it” can be responsibly maintained. The goal of creating a dividend income stream should be to eventually use just the dividends letting the principal continue to grow. It is analogous to living off the fruits of a tree rather than cutting down the tree itself, dividend payments can eventually provide an income stream that is sustainable since you don’t have to erode the principal.
This post was inspired by an interesting post the other day from a great dividend sites Sure Dividend that explored the idea of dividends paying stocks like a tree,
You start with something small – an actual seed, or a bit of hard-earned money.
Before you plant your seed or invest your money, you have to find the right place to put your tree seed or your money. Throwing a seed onto a rock will not do, nor will investing in a business on its last legs.
Over time, your sapling becomes a tree. It now is producing seeds of its own. Your dividend stock’s payments have grown over time. In both cases, the cycle begins anew.
The tree’s seeds beget more trees. The dividend stock’s dividend payments are reinvested into other high quality dividend growth stocks.
Once your first tree produces other trees, eventually you will have a forest of trees – let’s say they are fruit bearing trees.
You can now happily live off the sustenance your fruit trees provide.
Dividend stocks are the same way. Over time, your dividend income will grow. You will be able to live on the dividend payments of your dividend stocks.
Your Goal Should be to Live off the Dividends and Leave the Principal
Every time you eat into principal you are affecting your future income. If you have a $500,000 portfolio yielding 4% ($20,000), but you sell another $20,000 of principal you are looking at $480,000 if that were to yield that same 4% (ignoring the growth of the underlying assets) you are looking $19,200 the following year. Again, this is compounded when you still need that same $40,000 (now it is $19,200 of dividends and $20,800 of principal0. In addition to the natural erosion of principal the problem compounds itself if it is a down year.
I am not sure if I’ll ever be able to a large enough portfolio where I can solely live off the dividends, but it’ll be a nice part of the income investments I’d like to create over the next few decades.