Living off your share portfolio means you can rely on your investments to meet your expenses. The need to work to make a living is eliminated, leaving you with the most valuable resource of all – time. Your time is free to dedicate to the pursuits that mean the most to you.
So, how do you build a share portfolio that you can live off?
As mentioned, you'll need a portfolio that generates enough income to meet your living expenses. Not all shares are created equal in this regard – if the primary purpose of your portfolio is to generate income, you'll want to opt for shares that pay higher dividends.
Profits and dividends
Shares represent part ownership of a company and give the holder a right to a share in company profits. That is, if 1) the company is generating profits, and 2) the company is distributing profits. Some companies retain profits to invest towards future growth. Other companies make it a policy to pay out a certain proportion of profits.
A company's dividend yield is its annual dividend divided by the share price. It represents the dividend-only return on a share investment. When dividends remain the same, the dividend yield on a share will rise when the share price falls, and fall when the share price rises.
Generally larger, more mature companies in stable industries with steady cash flows will be in a position to pay out more of their profits as dividends, thus have higher dividend yields. Younger, developing companies and companies in cyclical industries or sectors with unpredictable cash flows are less likely to be able to make predictable dividend payments.
The payout ratio refers to the proportion of profits that a company pays out as dividends. Some companies have a target payout ratio that they try to achieve. Coles Group Ltd (ASX: COL) has a payout ratio of 80-90%, while AGL Energy Limited (ASX: AGL) has a payout ratio of 75%.
Choosing shares with higher payout ratios means you will tend to receive a greater proportion of company profits as dividends.
Diversification
When choosing high yielding shares to live off, it is important not to put all your eggs in one basket. If you invest in only a handful of companies you are likely to be adversely impacted if one or two go through a negative period and cut dividends. By casting your net more widely you reduce the impact of volatility on your portfolio.
Diversifying is best done by sectors and industries, as well as companies. If all your shares are in a single industry, your portfolio is at risk if there is an industry-wide downturn. Likewise, by diversifying across sectors you will avoid being left behind if one sector, for example, resources, is racing ahead, while another, such as consumer staples, is growing more slowly.
Banks
The big four banks have traditionally been known for dividends, and provide payout ratios of 75–80%.
Thanks to the downturn in its share price caused by the AUSTRAC scandal, Westpac Banking Corp (ASX: WBC) is currently yielding over 7%. Westpac paid $1.74 of dividends in 2019, fully franked. The bank cut its final dividend for the first time in a decade in November, from 94 cents to 80 cents, as profits fell 15%. Westpac blamed the drop on weak credit growth, falling interest rates, and higher costs.
National Australian Bank Ltd (ASX: NAB) is yielding 6.55% and paid dividends of $1.66 per share in 2019, fully franked. In May NAB cut its interim dividend to from 99 cents to 83 cents, concluding that 99 cents was not currently sustainable. The bank continues to grapple with weak conditions and higher than expected customer remediation costs.
Australia and New Zealand Banking Group (ASX: ANZ) is yielding 6.45% and paid dividends of $1.60 per share in 2019. Although the bank did not cut dividends, it cut franking credits on the final dividend of 80 cents, which was only 70% franked.
Commonwealth Bank of Australia (ASX: CBA) has not cut dividends or franking credits and is yielding 5.49%.
Resources
Resources shares have given impressive dividends in 2019, boosted by commodity price tailwinds. Resources revenues do, however, tend to be cyclical as demand for commodities is dependent on economic growth.
BHP Group Ltd (ASX: BHP) paid dividends of 191.7 cents per share in 2019, fully franked, not including a special dividend of 141.27 cents per share which was declared in December last year and paid in January. The miner has increased its dividend every year since 2010, with the exception of 2016 when it axed its progressive dividend policy. BHP is currently yielding 5.15%.
Rio Tinto Ltd (ASX: RIO) has paid dividends of 307.58 cents per share in 2019, fully franked. Like BHP, Rio has increased its dividend every year since 2010 (other than 2016). Rio currently has a dividend yield of 4.17%.
Consumer Staples
Companies in the consumer staples sector are considered recession resistant as people will continue to buy from them regardless of the state of the economy. Consumer staples companies can offer a safe haven that generates consistent returns in times of economic downturn.
Coles Group Ltd (ASX: COL) has paid dividends of 35.5 cents in dividends per share in 2019, fully franked, following its demerger from Wesfarmers in late 2018. Coles currently has a dividend yield of 1.58%, however shares are trading near record highs.
Woolworths Group Ltd (ASX: WOW) paid dividends of 102 cents per share in 2019, fully franked. The retailer currently has a dividend yield of 2.70%, with shares having climbed nearly a third over the course of 2019.
Foolish takeaway
Dividend shares are usually established companies with a track record of distributing profits to shareholders. Dividends provide a valuable income stream while the underlying shares provide the potential for capital growth, and franked dividends can also provide useful tax benefits.
