Like many investors, I receive dividend income from the stocks I own. In my case, dividend-paying stocks represent the core part of my portfolio. But just how much would I need to earn from dividends to live off this income alone? And would it be possible?

Let’s take a close look.

How could it work?

Well, I’d want to build a portfolio of dividend stocks that collectively pay me enough money to live from. Let’s say this is £30,000, but I appreciate this might not be possible in London.

And I’d want to be doing this within an ISA wrapper. That’s because any capital gains, dividends, or interest earned within the ISA portfolio is tax-free.

So, if I was earning £30,000 from dividends, I’d actually be taking home more money than someone on a £45,000 salary — including student loan repayments.

Of course, unless I picked specific stocks, I wouldn’t expect this income to be spread evenly across the year. At this moment, the majority of my portfolio’s income comes around April and May, shortly after the end of the financial year. So that’s something to bear in mind.

Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.

What would it take?

Well, to earn £30,000, I’d need to have at least £375,000 invested in stocks. That’s because I believe the best dividend I can achieve is around 8%. This would involve investing in companies, like Legal & General, that don’t offer much in the way of share price gains.

But what if we don’t have £375,000? And let’s face it, the majority of us don’t.

Well, I’d need to build a portfolio over time. And I could do that using a compound returns strategy. This involves reinvesting my dividends and earning interest on my interest. It’s very much like a snowball effect. 

Naturally, there are several key variables here. The starting figure, the yield I can achieve, and the amount of money I contribute from my salary every month.

If I started with £10,000 and stocks yielding 8%, in theory I could reach £375,000 in 19 years. But this would require me to contribute £400 a month and increased this contribution by 5% annually throughout those 19 years.

And by contributing £400 a month, I’d fall way under the maximum annual ISA contribution of £20,000.

Compound returns isn’t a perfect science, and as with any investment, I could lose money. But it’s certainly safer than investing in growth stocks.

About the stocks

Of course, the above is great in theory, but I’d need to pick the right stocks. I’m looking for stocks with strong dividend yields, but I also need to be wary. Big dividend yields can be a warning sign, and the dividend coverage ratio is a good place to start.

Right now, I’d start with Legal & General (8.4% yield), Phoenix Group (9.1%) and Vistry Group (7.3%). Collectively, these investments would offer me a yield around 8%.

The post How I could live off dividend income alone! appeared first on The Motley Fool UK.

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James Fox has positions in Legal & General Group Plc, Phoenix Group Holdings Plc,  Vistry Group Plc. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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