Friday, June 26, 2020

Managing Your Passive Dividend Income

The Bedokian Portfolio’s mantra is “passive income through dividend and index investing”. During the portfolio building phase, staying the course of dividend and index investing (peppered with some growth and value styles if you deem fit) through the ups and downs of the markets is correct; some years you will get more, others you may get less. However, if you are presently at the passive income phase, and with down periods such as the ongoing COVID-19 situation, your dividend income stream will definitely be affected one way or another (assuming you have no other forms of income stream).

 

Though I have yet to reach the passive income stage, I have a plan in place to execute it. The plan involves knowing exactly how much you would have in the coming year, so in lean years like this, I would not be caught off guard. In other words, I need not worry on the lesser amounts of dividends I am getting this year, and I will be less worried next year because I knew how much I am going to have.

 

So, what is the secret? It is pretty simple actually. The dividends that you are getting this year is going to be your next year’s income.

 

To practice this, you would have to start on the day that you have decided to convert your portfolio into a passive income machine. Or, if you want to continue working, to step down from the rat race and do a job that you really like, without pressure. And no, that “day” is not going to be your last working day, but it is the day which you decide to quit in exactly one year’s time. In this 365-day (or 366-day if leap year) duration, your income is from work, while the dividends collected from your portfolio will form up your next year’s income (instead of going into the cash component of the portfolio). After the year is done, you quit and start to treat last year’s dividends as your current year’s pay, while this year’s dividends will be next year’s pay, and so on.

 

The main advantage here is that you will suffer less from income shock, since you knew how much you will be having. A year’s head start gives you ample time to plan ahead and decide if you should live lean (e.g. forego an overseas trip or a big purchase), drawdown further from your portfolio and/or take up some gig or job stint to cover the shortfall. On the investment front, if last year was a bumper crop and this year is down, you can make use of your last year’s enlarged dividends to buy undervalued securities in the bear market to enlarge your portfolio.

 

For those who had begun their dividend income journey, I believe you already have a plan in place and it could be working well for you. However, if you decide to shift to the method above, then the “work income” for the initial year may need to be drawn from your portfolio if you are currently not working or the work income is not enough to supplement it.

 

To formalize your dividend income further, you may want to implement the concept of a monthly pay by dividing the total amount by 12, treating it as a salary to be drawn every month. Since most of us are/were salaried employees, it could reinforce prudent spending and savings (and investing) that we were so used to, even if we are really not working.


2 comments:

  1. this is sort of like saying that you should have 12mth expenses as emergency cash fund.

    If your dividends drop below your monthly expenses, you will draw down this emergency cash fund to make up the difference. As you are using both your reduced dividend+emergency fund, it should last for more than 12mth which should be sufficient time for stock market to recover.

    If market recovers - slowly build up your emergency fund back to 12mth
    If market don't recover - adjust to a lower standard of living.

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    Replies
    1. Hello World,

      This is an interesting perspective, meaning that the previous year's dividends will be used as an emergency fund or buffer against the drop in current year's dividend income stream.

      The expectation of dividend income should be that of a business income, which has ups and downs. They could make it more "stable" (i.e. having the same payout throughout) either by your suggestion or a drawdown from the portfolio itself.

      They are other dimensions of managing the overall finances (such as classifying expenses into basic and discretionary, etc.) which I think may need a book to cover.

      Cheers!


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