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investor clinic

How much does one need to invest before one's dividends pay for basic monthly expenses in retirement? I realize there are a lot of variables, but this is a very general question.

You're correct that there are a lot of variables, but let's do some very rough math. We'll assume you're retiring today, and for simplicity we'll ignore taxes (which may not be a big factor anyway, thanks to the dividend tax credit. For more on this, see my Yield Hog column from this week).

Let's further assume that your investment portfolio yields 3.75 per cent, calculated as total annual dividends divided by total market value. I didn't pull this number out of a hat; it's the yield of my Strategy Lab model dividend portfolio.

Could you construct a portfolio with a higher yield? Absolutely. But in my opinion a diversified portfolio of stocks yielding 3.75 per cent is easily achievable without taking on excessive risk.

Now, we need to determine what your basic expenses would be in retirement, keeping in mind that a lot of costs – raising kids and paying the mortgage, for example – may well be behind you. Let's assume you can get by on $50,000 for basic expenses such as food, property taxes, clothing, transportation and utilities. Granted, this doesn't leave room for lavish Mediterranean cruises or a new Lexus every few years, but you won't be eating cat food, either.

My family of four, for example, lives comfortably on less than that. I know this because I have tracked our expenses for the past several years. I recommend you do the same; it's the only way to know how much money is actually going out the door. One of the easiest ways to track your spending is to keep all of your bank and credit card statements, and then review them each year to see how much you've spent.

Now the question is, how much capital do you need in order to generate that $50,000 in annual income, assuming a yield of 3.75 per cent? The answer is: $50,000/0.0375, or $1.33-million.

Think you could get by on $40,000? You'd need a portfolio of $40,000/0.0375, or about $1.07-million. If you assume a higher dividend yield of, say, 4 per cent, you'd need a portfolio of $40,000/0.04, or $1-million.

You can play around with different scenarios on your own. The general formula is X/Y = Z, where X is your annual expenses, Y is the portfolio yield expressed as a decimal, and Z is the required portfolio value. As long as you know two of those numbers, you can solve for the third.

What about inflation? Well, if you own stocks that raise their dividends regularly, as many pipelines, utilities, banks and consumer companies do, your income will grow and protect you from rising prices.

Bear in mind that most investment professionals recommend that you also allocate a portion of your portfolio to bonds or guaranteed investment certificates. When the stock market takes a dive, you'll be glad you have them.

Remember, too, that you may well have other sources of income in retirement, including the Canada Pension Plan, Old Age Security, registered savings and, if you're fortunate, a company pension as well. So you probably won't have to rely on dividends for all of your spending needs. But having some dividend income in retirement will certainly help.

There are a lot of moving parts here, and this analysis is general in nature and not meant to be taken as specific investment advice. A good financial planner can put together a comprehensive plan that addresses your specific situation.

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