Many Australians may love the idea of retiring at an age where they can enjoy a high level of dividend cash flow, such as $80,000 per year, at 55 years old, or even younger.
Saving money is obviously a key factor in building significant dividend income.
To invest, an Australian needs to have the money to do so. The key to do that? Spend less than you earn.
Aussies can unlock savings by increasing income, reducing expenses, or both. How that happens depends on each Australian, as every household's finances (and ability to change things) are different.
The most important thing is what to do with those savings once they've been accumulated.
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Compounding assets will help the most
Imagine someone saves $500 per month and they decide to put it under the mattress. After a year, they'd have $6,000. After ten years, there'd be $60,000 under the bed. After 25 years, it would be an impressive $150,000. Not quite enough to retire.
It's good to save, but putting that money to work and earning a return can unlock greater wealth building. Compounding is a very powerful force.
Just putting the money in a savings account earning a 5% interest rate can help it become a much larger figure. If that same person saves $500 per month and it earns 5% per year, it becomes $6,139 after a year, $77,641 after ten years, and $297,755 after 25 years.
Simply putting the money to work in a bank account could add an extra $147,000 after 25 years – 98.5% more.
It's important for our dollars to grow to help offset the negative impact of inflation, meaning $1 will have less buying power in a decade and significantly less in 25 years. The best protection against inflation could be to invest in ASX shares.
Over the long term, the global stock market has returned an average of around 10% per year. That's the average return, including both the good years and the bad years.
If that same person who saves $500 per month invested in the stock market and saw a 10% annual return, they'd have $95,625 after 10 years and $590,082 after 25 years. That's a solid amount to help someone retire.
There are a wide variety of simple investments that we could use to generate a long-term return of 10% per year (or more) because of the types of investments they buy and the global nature of the portfolios, including Vanguard MSCI Index International Shares ETF (ASX: VGS), BetaShares Diversified All Growth ETF (ASX: DHHF), and VanEck MSCI International Quality ETF (ASX: QUAL).
How to retire on $80,000 a year at 55
Every Australian has a different financial starting position and is a different age.
I'm going to imagine someone who's 27 years old, has already invested $10,000, and wants to invest $1,000 per month. If their investing achieves an average of 10% per year over the next 28 years until they're 55, they would have $1.75 million. Someone younger has more time to compound, while someone older will have to invest a bit more per month to achieve the same results.
If that person assumes a dividend yield (or withdrawal rate) of 5%, it would be annual income of $87,500 from a $1.75 million portfolio. That means the person could target a dividend yield of 4.6% and get the desired $80,000 per year.
There are a variety of investments that could provide both diversification and a dividend yield of more than 4.6% (including franking credits) today, and perhaps in two or three decades, including MFF Capital Investments Ltd (ASX: MFF), Vanguard Australian Shares High Yield ETF (ASX: VHY), Argo Investments Ltd (ASX: ARG), Australian United Investment Company Ltd (ASX: AUI), and Rural Funds Group (ASX: RFF).
