14 Jul 2023

Are equity dividends a good source of retirement income?

Receiving dividends brings a smile to direct equity investors. You are doing your own thing, and all of a sudden you get some money. Free money. What’s not to like about it?

People who aim to achieve financial independence through direct equity investments calculate how much of their annual expenses can be met through dividends alone. Living off of dividend income is like a dream. You still hold just as many shares as before, and yet you have more money to spend.

‘Dividends’ by Nick Youngson CC BY-SA 3.0 Pix4free.org

I wanted to build a direct equity portfolio too, to derive dividend income to cover my expenses after retirement. I haven’t acted on that desire, but I have been thinking about it. After thinking about it for a while, it does not sounds as appealing anymore.

  • A company that pays dividends is essentially choosing not to use the cash for business growth or expansion. Doesn’t that mean that this business may potentially be at risk when its current source of revenue dries up? Do we really want such companies to be a big chunk of our corpus?
  • Dividends are unpredictable. You may get ₹15 a share this year, and ₹2 a share next year. How do you even make a budget around such an unpredictable income source? You need a reliable source of income as the base. On top of that stable base, you can add equity dividends like a decoration.

What investments give you reliable income then? Those are bonds, for sure, since you know how much coupon they will pay. A little less predictable but still good are REITs and InvITs. REITs and InvITs don’t pay a predictable sum (such as ₹50 per share) regularly, but they are required to distribute 90% of their cash. While a company is free to not pay equity dividends for a few years, that flexibility is not available to REITs and InvITs. This means the investor can expect to see a reasonable inflow of cash.

My current stance

Given all this, I am not sure if building a direct equity portfolio for dividend income is a good move. Maybe it is better to invest in equity only for growth. Mutual funds that reinvest the equity dividends can be a good way to hold equity: you are not banking on dividends. Whatever dividend is earned will be efficiently and automatically reinvested by the fund management team, which optimises for rapid growth.

For retirement income, i.e. to pay for day-to-day expenses, we can use bonds, REITs, and InvITs. These assets do not grow rapidly, but that’s not a bad thing.

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