Capital required to live off dividend income in India

Capital required to live off dividend income in India

Do you know the only thing that gives me pleasure? It’s to see my dividends coming in” John D. Rockefeller
This quote from John Rockefeller, one of the wealthiest person in modern history, beautifully articulates an investor’s love for receiving dividends. Little surprise then that dividend investing remains a very popular investment strategy.
Over the weekend, a friend of mine shared his investing goal to make his dividend income fully cover his regular monthly expenses. He quizzed me on how much investment capital would be needed for this goal to be achieved?
This post is an attempt to find a data driven answer for my friend’s question.

Breaking down my friend’s question, answers need to be found for:

  • How much monthly expenses do we need to cover?
  • How much investment capital would be needed to earn this monthly expense amount as dividends?

I am a firm believer in what Leonardo da Vinci said “Simplicity is the ultimate sophistication”.
With that in mind, I have kept out the effects of capital appreciation / compounding / reinvesting of dividends and tax implications of dividend income from my calculations.
The general idea is to be conservative with the capital estimations and also to be approximately right than be precisely wrong.
Let’s get started…

How much monthly?

Firstly, we would need to arrive at an acceptable level of monthly expenses amount which needs to be generated through dividends for a normal Indian investor. To arrive at a precise value is a futile exercise as the number of variables which influence the average monthly expenses are one too many.
The monthly expenses may vary based on the number of members in a family, life stage of the investor (early twenties / early forties / sixties), investor’s lifestyle, current liabilities (Housing loan / car loan/ personal loan), and also the place of residence (Mumbai vs a tier 3 town) among other things.
Enter Numbeo. Numbeo is the world’s largest database of user contributed data about cities and countries worldwide. Based on the cost of living data inputs available at Numbeo, answers on Quora and my own educated guess, I have come up with a range of possible three values.

Possible monthly expenses values

monthly expenses range

Assumptions

*Interim dividends may be paid any number of times during the financial year but for simplicity sake the dividend payout on an annual basis is considered for calculations.
** “Minimum value” amount is assumed for a person with a frugal lifestyle / a resident of tier 3 town / a two member family mostly in retirement phase.  If you feel the amount to be considered in your individual case is different then simply substitute your actual monthly expenses in the calculations.
*** It is assumed that the investor stays in an own house without incurring any rental or housing loan EMI expenses. This component really skews the calculations as the rental / EMI expenses for a house in a Tier 1 city like Mumbai is significantly higher than that in a Tier 3 city.
So there we have it: We need to plan for covering  monthly expenses of INR 25,000 to INR 1,00,000.
Next comes the second question: How much capital outlay is required to cover the above expense as dividend income?

How much Capital

The investment capital outlay required to cover the monthly expenses by dividend is also dependent on multiple factors like the investment strategy followed, investor’s ability to identify quality dividend stocks, a long term orientation with strong dividend focus among others.
The most important of them is the stock selection process for identifying quality dividend stocks.
With this in mind, for our calculations, we will look at three different scenarios to arrive at the capital outlay required.

Scenario 1

In this scenario, we will use the NIFTY 50 Index of National stock exchange as a proxy for capturing the cash dividend from stock investments. The fundamental assumption here is that the investor is investing in large cap stocks with good fundamentals and which are representative of the various sectors of the Indian economy.
To arrive at the investment amount required, we need to find arrive at the expected dividend yield.
The daily dividend yield of NIFTY 50 index can be the found in the NSE India website here .

Dividend yield of Nifty 50 as on September 1, 2017

Nifty dividend yield_sep 2
The current dividend yield comes to 0.93%. Let us take a slightly longer term view and check the historic data.

Dividend yield of NIFTY 50 from 2005 till Sep. 2017

Nifty historical dividend yield
From a dividend yield of 2.25% in 2008 it has fallen to 0.93% as of September 2, 2017. As you can see from the charts, the dividend yield has been mostly in the range of  1% and 2% for the past decade. Also from the above chart we can infer and arrive at an approximate average dividend yield of 1.25% for Nifty 50. We will use this value for our calculations.

Capital required at 1.25% dividend yield

capital required for scenario 1
The investment capital required is INR 2.40 crores, 4.80 crores and 9.60 crores respectively.

[Calculation logic

Dividend yield = (Total dividends paid for the year / Share price) X 100.
Simply put the dividend yield tells you how much percentage your shares are earning as dividends at the current market price. E.g. Let us say you own shares of ABC ltd which declared INR 50 per share as dividend for the year and the current market price is INR 500.
Dividend yield = (50 / 500) x 100 = 10%
Now if you wish to have INR 50,000 as yearly dividend income then we can calculate the investment amount required.
Capital required     = Expected Dividend Income / dividend yield %
= 50,000 / 10%
= INR 5, 00,000]

Scenario 2

A smart investor focused on dividend investing strategy is more likely to invest in stocks with high dividend yields without compromising on their underlying quality. Stocks with an abnormally high dividend yields, say above 6%, may not be sustainable and hence considered not ideal for long term dividend investing.
A more suitable benchmark for this strategy of investing in high yield dividend stocks will be the NIFTY dividend opportunities 50 Index .
From the NSE website

The NIFTY Dividend Opportunities 50 Index is designed to provide exposure to high yielding companies listed on NSE while meeting stability and tradability requirements. The NIFTY Dividend Opportunities 50 Index comprises of 50 companies. The methodology employs a yield driven selection criteria that aims to maximize yield while providing stability and tradability.

The historical data can be found here and the average dividend yield hovers around 2.5% (twice the Nifty 50 yield).

Dividend yield of Nifty Dividend Opportunities 50 on Sep 1, 2017

Nifty Opportunity dividend index September 2
The current dividend yield in this scenario works out to 2.42%

Capital required at 2.42% dividend yield

capital required for scenario 2
The investment capital required is INR 1.24 crores, 2.48 crores and 4.96 crores respectively with almost 50% reduction than scenario 1.

Scenario 3

This is a hypothetical scenario where we assume that the investor is able to get more yield than the average dividend yield of the indices. The reasons could range from investor’s superior skills for picking fine dividend stocks or it could be just plain luck.
Whatever be the reason, in scenario 3, let us assume that investor is able to get an above average 4% dividend yield consistently over a long period of time.

Capital required for dividend yields at 4%

capital required for scenario 3
The investment capital required is INR 0.75 crores, 1.50 crores and 3 crores respectively for a 4% dividend yield with a further almost 50% reduction from scenario 2.

Consolidated Summary of the three scenarios

The consolidated summary of investment outlay required under all the three scenarios:
capital required consolidated Summary
It is obvious that investors needs a significant capital outlay, an amount in seven figures (crore / 10 million) if they harbor dreams of living off only dividend income.

Fine yet Significant points

The objective of this post is to find out the capital requirements by keeping the key assumptions simple. However, for the thoughtful investor, there are a few fine yet significant factors which have significant implications for the capital outlay calculations:

Tax on Dividend Income

The rules governing the taxation of dividend  income at the hands of the beneficiary has a significant influence on the returns obtained by the investor. Currently dividend is tax free in the hands of the investor up to INR 10 lacs (1 million) with a dividend distribution tax  levied on the company for the dividend declared.
Sudden and frequent changes like the introduction of 10% tax on dividends over 10 lacs per annum in budget 2016 or the amendment to Finance act on grossing up of dividends for calculation of dividend distribution tax leads to a change in dividends received. This in turn leads to a rethinking of the investing strategy followed (as the risk reward ratio has changed).

Reinvestment of Dividend

Investors have the opportunity to reinvest the dividends received to achieve compounding returns. Studies have shown that reinvestment of dividends leads to a  significant increase in total returns  (up to 1.5% per year for the last 14 years). This will result in lower investment capital outlay.

Earnings growth and Inflation 

Over time as the business grows, there would be a corresponding growth in earnings of the underlying stock too. This in turn will lead to a larger dividend income for the investors over the long term.
On the flip side, inflation also has an impact on the investor’s purchasing power. The value of INR 100 ten years down the line is not the same as the value of INR 100 as of today. Hence the investor needs to factor for all these in their capital outlay calculations.

Final thoughts

The dream of an investor to meet his monthly expenses completely out of dividend income is certainly not a thing of fantasy. But for realizing this fantasy it may require a significant capital outlay, probably a seven figure amount, considering the current dividend yields prevalent in the market. The investor is better served by focusing on total returns where capital appreciation also forms a part of their investing strategy along with dividend returns.
However, with a focused dividend investing strategy practiced consistently over a long period, an investor can surely aim to cover a significant portion of his monthly expenses via dividend income.

Additional reading

40 things every dividend investor should know
5 keys to successful dividend investing

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