It’s a dream for many to be able to achieve financial freedom – a stage where you can choose to work or play without having to worry about where you’re going to get money to pay for your lifestyle.
While this may be a dream many of us keep alive with hopeful visits to the TOTO outlet, there are definitive steps we can take today, no matter where we’re at in life, to start building towards this goal.
What Is A Dividend Income Portfolio?
When you buy certain stocks, you get dividend payouts, based on its profits, over the year. The goal is to be able to invest enough into stocks so that the dividends you receive each year is able to cover your yearly expenses.
Essentially, you’re building investment portfolio that can replace your salary.
How To Start Building A Dividend Income Portfolio
To start building your dividend income portfolio, you need to identify solid companies or investments with a strong history of paying out good and stable dividends every year. This is because you are not aiming to invest in companies that are investing heavily in growing its operations or involved in very volatile businesses.
There are two main ways to go about building your dividend income portfolio – 1) Investing in stocks and 2) Investing in unit trust and exchange traded funds (ETFs). The good thing is that it isn’t an “either-or” decision, and you can choose a combination of the two based on your level of knowledge and ability.
Investing In Stocks
When you decide to invest in stocks, you need to be able to monitor your investments more closely. This is because individual stocks may carry risks that are unique to itself, such as its management team doing a bad job, being saddled with a crisis, or losing out to competitors in its market.
You also need to identify the right kinds of companies to invest in. In recent times, real estate investment trusts (REITs) have been very popular, as they pay out over 90% of its profits. This provides strong visibility into the timing and amount of future dividends.
Blue-chip companies are another option. They are often very large and stable companies that have a long history of positive business track record, and include companies like DBS, Singtel and Keppel Corporation in Singapore. This characteristic enables them to have a good prediction of their business performance which ultimately allows them to pay out profits to shareholders as dividends.
Smaller companies may also be able to deliver solid returns in terms of dividends over time. However, you may need to dedicate even more time to these investments as smaller companies tend to be more volatile in nature. You will need to “spot” these companies early as the share price for good companies will quickly rise, thus lowering any dividend yield. dividend payouts by smaller companies also tend to be more erratic as they are still in the growth phase and may, from time to time, plough profits into new investments. You would also need to keep track of its operational performance more closely that blue-chip companies, keeping an eye on free cashflow, payout ratios and profitability levels. These can affect long-term dividends of companies.
The thing to remember when you invest into individual companies is to ensure that you’re well-diversified and that you regularly monitor your investments.
Investing In Unit Trusts And ETFs
The main difference between investing in unit trusts and ETFs compared to investing in stocks is that you’re not required to do much of the heavy lifting, such as monitoring, diversifying and buying decisions.
Unit trusts pool money from a large number of investors to build a diversified investment portfolio. You can go on platforms such as DollarDex (powered by Aviva) or FSMOne (powered by FundSupermart) to invest into unit trusts that’ are either focused on blue-chip companies, high-dividend companies or REITs. Pay close attention to the fees you have to pay on unit trusts as they can eat into your returns over the long-term.
You could also choose to invest in country ETFs. They offer a lower-cost way to invest into blue-chip companies. ETFs are typically comprised of the strongest and most liquid public companies in a country, and they are also usually the companies that are able to pay out good dividends on a regular basis.
In Singapore, the Straits Times Index ETF is comprised of the 30 strongest and most liquid companies listed here. In Hong Kong, they have the Hang Seng Index (HSI); in the US, they have the Standard & Poors 500 (S&P 500); and in Europe, there’s the FTSE 100 which tracks the London Stock Exchange. These are all options to invest into the strongest companies listed in the stock exchanges across the world.
By investing in unit trust and ETFs, you have a portfolio that’s inherently diversified. What this means for your dividend income is that even if one or two companies pay out less dividends in any particular year, you overall dividend does not fall by much, or it may even be offset by companies that are able to pay slightly higher dividends that year.
This may be a good way for beginner investors to get started on their dividend income portfolio, and gradually allocate part of it to individual investments.
Consider Diversifying Into Other Asset Classes
You could also choose to receive some income in the form of coupon payouts from a bond investment, lend out money through peer-to-peer (P2P) lending platforms such as Funding Societies or even rent from an investment property.
Read Also: 3 Alternatives To A Dividend Portfolio
By putting your money into different asset classes, you will be able to better spread your risks and potential retirement income.
You Always Have To Think About The Long Term
With Singapore being such an expensive place to live, it’s a tough ask to be able to put aside a large proportion of our salaries each month for our retirement. This is why we should start planning for it as early as possible, and stash away a small amount each year.
We should also reinvest the dividends every year to compound our investments over the years, and build it up to a substantial amount.
Another important consideration is that as we earn more after our initial years in the job market, we should try to limit any inflation in our lifestyles. An extra holiday each year, an expensive wedding, a car – these are expenses we may be able to pay for with our rising salaries, but may hamper our retirement plans.
Also, we can be slightly ambitious with our savings and investment levels. This is because even if we eventually fall short of our plans, we may be able to enjoy earlier partial retirement, rather than full retirement, and once we hit 65, CPF LIFE may be able to make up the difference for a stress-free retirement.