ASX dividend shares are a great tool to produce passive income to help investors grow an alternative source of money to flow in. Aussies can build so much dividend income that it could replace a wage.
I think the last four years have shown the importance of having an additional source of income to provide support when households need a bit of extra income. Hopefully, it'll be a very long time before the next pandemic or bout of strong inflation.
Companies can pay dividends from the profit they generate each year – investors don't need to do anything but sit back and watch the money roll in. It can be a very laid-back lifestyle.
In my mind, there are four steps to replacing a wage with ASX dividends.
Start saving
It takes money to make money in the ASX share market. We can't build a portfolio of dividend-paying investments without having the cash to buy the shares.
It might be tricky for some households to find savings at the moment, but there may be some choices people can make to manage to put aside some savings each month. Other households may be able to allocate many thousands of dollars to invest each month.
I'd suggest putting that saved money in a savings account until it's invested so that it can generate interest and result in there being more to invest.
How much should someone save before investing? Many online brokers want a minimum of $500 for a transaction, though I'd suggest (at least) around $1,000 to save on brokerage. Some brokers charge less brokerage for an investment of less than $1,000.
Identify the right ASX dividend share investments
Building towards a large total of passive income requires time, so I think it would be a wise idea to choose investments that are delivering growth themselves and help fund a lot of that growth.
The less of our own money we need to invest into the portfolio, the easier it might be to reach $70,000 (or more) of annual passive income.
I like businesses that have a history of growing their payout most years thanks to sustainable long-term profit growth. Examples of businesses with a lot of dividend growth include Washington H. Soul Pattinson and Co. Ltd (ASX: SOL), Brickworks Limited (ASX: BKW), Sonic Healthcare Ltd (ASX: SHL), Pinnacle Investment Management Group Ltd (ASX: PNI), Lovisa Holdings Ltd (ASX: LOV), APA Group (ASX: APA) and Wesfarmers Ltd (ASX: WES).
Reinvest and be patient
We can't expect to reach the goal in a short amount of time, so it's a good idea to be patient as we build towards the total.
One of the best ways to help grow our financial wealth is to reinvest any dividends received into buying more shares. That can be utilising each business' dividend reinvestment plan (DRP), or taking the dividend as cash and then putting the money into new shares ourselves.
Let's imagine we're aiming for $70,000 of annual ASX dividends with a yield of 5% and we're able to invest $1,500 per month, with investment returns of an average of 10% per annum. Using a compound interest calculator, the numbers say it would take 23 years to reach $1.4 million.
Financial independence!
If investors have chosen their investments prudently, once the annual passive income total is reached, dividend growth could continue in the subsequent years, boosting how much income we can get.
We're now wealthy and can retire early if we wish to. But, reaching financial independence also gives us the option of changing to a more satisfying job, even if it means not as much earnings from work.
Replacing a wage with ASX dividends won't be easy, but by using compounding and time we can build towards a great amount of cash flow.
