Reinvesting my dividends to grow my biggest passive income stream

In my previous post, I wrote about increasing my income streams and desiring passive income, in particular. I define passive income as income that I make in my sleep or income produced without much effort from me.

Yes, I know – this is everyone’s dream, isn’t it?

Ah, but I am a dreamer 🙂

I only started to track my income recently. And to my surprise, dividends from my share portfolio was my BEST source of passive income.

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What are dividends?

When we buy shares on the stock market, we are essentially buying a part (or a share) of a company that is listed on a stock exchange.

Companies listed on a stock exchange allow investors like you and me (ordinary people) to own a part of their company. 

As a reward, the companies may pay us a dividend or a share of their profits. 

These dividends are typically paid a few times a year.

And are paid according to how many shares you own at that time.

Reinvesting dividends

Of course once you receive your dividends, it is up to you as to how to spend the bonanza 🙂 

However when you first start investing in shares, it is not quite the ‘bonanza’ – it takes time to build up your shares and for those dividends to grow. Unless you win the lottery or inherit a big lump sum of money that you can invest all at once.

If you are like me and depend on an active income stream (aka a full time job) to fund share purchases, then it will take time to slowly build that portfolio and hence, dividend income.

I set aside an amount each week from my pay to invest in shares. 

But in addition to this strategy, I choose to reinvest my dividends ie I use my dividends to purchase more shares.

Therefore reinvesting my dividends is the extra fuel I use to build my portfolio. 

My passive income is building my passive income.

How to reinvest your dividends

There are two ways in which to reinvest your dividends – manually or automatically.

You accumulate dividends to a certain amount and decide which share you’d like to purchase. It can be more shares of the same company or a different company. You then purchase the shares via your brokerage firm. This is the manual method.

Personally, I like the automatic method better.

Some companies offer a dividend reinvestment plan (DRP). 

This means that the dividends can be used to purchase more shares in the same company. Typically there is a slight discount on the share price when compared to the market price that day.

Instead of getting a cheque or cash deposited into your nominated bank account, you will get more shares in the company.

Because dividends are paid per share, you will receive more dividends based on the increased number of shares the next time dividends are paid. 

It can snowball from here.

You still need to pay tax on the dividends, regardless of whether you receive cash or use it to buy more shares. Because it is considered as income ie the ATO doesn’t care how you spend it.

Dividend reinvestment plan - how does it work?

Companies use share registries eg Computershare, Link Market Services etc to keep track of their shareholders, communication about dividends and so on.

Find out which share registry your company uses and set up online log in with the share registry. This information should be on the company website or on the paperwork which you’ll receive after your share purchase.

Log into the share registry and check if the company offers a dividend reinvestment plan.

I always elect this option if it is offered.

Ok, so how does it work?

Say, we purchase 100 shares in Company A

Twice a year in March and September, Company A pays dividends.

It announces in February that it will pay 10 cents per share in March

Woohoo, that means we’ll receive 10 cents x 100 shares = $10

On the day dividends are paid, instead of $10 hitting our bank account, it will be used to purchase more Company A shares.

For example, Company A shares cost $1 per share – we’ll receive 10 shares in March

So our total number of shares is now 110.

In September when the next dividend is payable, it will be calculated based on 110 shares.

Let’s say, Company A chooses to pay another 10 cents per share. We’ll receive 10 cents x 110 shares = $11

Then this $11 will purchase more shares at say, $1 per share which means we’ll now have an additional 11 shares and our total number of shares = 121

Of course this is a simplistic example. 

But it demonstrates how your shares can grow without any effort from you besides logging into the share registry and ticking yes to the DRP. 

And you haven’t contributed a single cent from your active income to grow this portfolio.

My dividends are increasing every year!

Advantages of dividend reinvestment plans

It is automatic. What can I say – I am a lazy person. Full stop.

Once it is set up, I know that every time dividends are paid, I will get more shares. And over time (sometimes a very long time), my shares are growing and I’ll receive more dividends next time. And more shares. The cycle goes on.

I don’t have to remember to reinvest those dividends. 

And be tempted to use the money for other stuff while it is accumulating. This is the main benefit for me – kind of enforced savings.

The other advantage is that I don’t pay a brokerage fee for these share purchases.

Disadvantages of dividend reinvestment plans

Depending on how much the dividends are, it may not be enough to purchase a single share in the company. It is then kept until the next time dividends are paid. Depending on the number of shares you hold, the dividends paid and the share price, it may take a few dividend cycles before you can purchase a single share.

For example, one share in VAS costs $90 and you own 50 shares at the time dividends are paid. Let’s say VAS decides to pay 50 cents per share. That means you’ll receive $25 for your dividend. This is not enough to buy one share at $90.

This $25 is kept in trust until the next dividend is paid.

VAS declares that it’ll pay 60 cents per share the next quarter. You still own 50 shares. So your dividend will be $30 this time. Combined with the previous dividend of $25, you still don’t have enough to purchase a single share, assuming that the share price is still $90. 

As you can see, it may take some time to increase your shares. 

And those small dividend payments are not accumulating interest while they are held in trust.

Records must be kept as to purchase price – you’ll need it when it’s time to sell those shares. I use Sharesight (affiliate link*) to track my portfolio so I don’t have to worry too much here.

(*affiliate linkyou get 10% off your annual payment when you sign up using my link, even if you start off with a free account)

You do need to review

While it is convenient to set and forget, you need to review at least once a year if it is still a good strategy to have a dividend reinvestment plan in place.

If the company isn’t performing, you may not want to continue investing in it. But then again, all companies have up and down times.

Because I only invest in LICs and ETFs from now on, I am comfortable with turning on DRP and leaving them turned on for the time being. All my individual shares (purchased before I knew about LICs and ETFs) are in the top 200 of the ASX and provide good dividends so I’ve left DRP turned on for the ones that do offer DRPs

Another time to consider turning off DRP will be at retirement when you can use the income to pay for living expenses.

Right now, I’m in the accumulation phase of my investment journey. 

Therefore I’m more than happy to keep reinvesting those dividends and to use dividend reinvestment plans to grow my portfolio.

 

Will dividend income be enough in early retirement?

My 3 phase retirement plan thus far has been –

Phase 1 – build a share portfolio outside of superannuation (retirement account) and save enough cash to fund years 55 to 60 (my bridge the gap fund)

Phase 2 – access superannuation at age 60

Phase 3 – sell paid up home to fund entry into aged care facility or other advanced care when I’m really really really old 

So far, phases 2 and 3 are taken care of, in that my home is paid off and by my calculation, my superannuation will be enough by the time I turn 60

That leaves phase 1.

The plan was always to sell down this share portfolio to fund the five years before Phase 2 kicks in. Because I don’t believe I have enough time to build up a big enough portfolio to generate the dividends I’d need. (The cash is to counter sequence of returns risk – I have not made any head start here, I admit)

I only have 5 more years to build this portfolio if I stick to my plan of retiring early at 55.

But you know what? I am sooooo attracted to the idea of living off my dividends. 

I just feel ‘safer’ if I can use the income generated, rather than selling those assets.

So now the experiment begins!

My dividends this calendar year, up to the end of September can cover 15% of my annual living expenses. I know it’s a long way to 100% but … I am keen to see where this is heading.

Final thoughts

Reinvesting my dividends automatically via dividend reinvestment plan is the best way for me to grow my portfolio. It is in addition to investing funds monthly.

I am using my passive income to grow future passive income 🙂

I have no idea if I can eventually live off my dividends but hey, I’m going to grow my portfolio regardless.

How do you reinvest your dividends?

Coast FI as a Late Starter to FIRE

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When I first came across the term “Coast FI”, I assumed that it meant living a FIRE lifestyle somewhere along the coast, perhaps near a beach. What a dream!

It is one of the many terms in the FIRE community, signifying the different levels of FIRE you can aim for – Lean FI, Fat FI, Slow FI, Barista FI, Flamingo FI and so on.

Me? I was just aiming for ordinary FIRE, or as close to FIRE as someone starting late could hope for!

What is Coast FI?

Four Pillar Freedom explains it as “having enough money invested at an early enough age that you no longer need to invest any more to achieve financial independence by age 65 (or whatever age you define as a retirement age)”

That is, you coast to financial independence once you’ve saved up enough money for it to grow by compound interest to the sum you need at traditional retirement. In the meantime, you just need enough income to support your current lifestyle without worrying about saving for your retirement.

Pretty neat, huh?

Except the bit about invested at an early enough age …

Well, that rules me out.

I am a late starter at all this investing and pursuing FIRE as I didn’t discover FIRE until my late forties.

So I dismissed the idea as interesting but unachievable.

Then Professor FIRE shared his story on the Late Starter to FI series, explaining that he is essentially at Coast FI despite starting late. Again, I dismissed it as a possibility for myself because I wasn’t earning a big enough salary.

Now, a couple of years after reading Four Pillar Freedom’s post on Coast FI, I think I’ve achieved this very milestone!

I’ve arrived at Coast FI as a late starter, woohoo!!!

How, you ask?

Super, baby, super! Or superannuation, Australia’s retirement account.

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Superannuation in a nutshell

The government mandates the minimum percentage of your gross salary that your employer must pay into your superannuation account. This is known as the Superannuation Guarantee and is set at 9.5% currently. There is considerable debate at the moment about whether it should be raised to 12% or whether employees would be better off with an increase in wages.

This contribution is taxed at 15% instead of your marginal income tax rate. Any investment returns is also taxed at 15%.

The current income tax rates in Australia are:

Up to $18200              Nil

$18201 – $45000        19%

$45001 – $120000      32%

$120001 – $180000    37%

$180001 upwards       45%

Therefore, the government has made it attractive for you to contribute to superannuation and save for retirement.

But wait, there’s more!

Once you are able to access your money in retirement, it can be withdrawn tax free and any investment returns in this pension mode is also tax free. There is a limit of $1.7 million ($1.6 million before 1 July 2021) that can be converted to this pension mode.

Of course there is a catch! And the catch is that … you can’t access your super until you are 60 (if you are born after 1 July 1964).

And because of this inaccessibility plus the automatic employer contribution, many forget that the money sitting in superannuation is YOUR money (ahem, I fell into this category!) And that investing it well is an important retirement strategy, whether you retire earlyish or not.

Back to my story

When I first started working nearly thirty years ago, superannuation was a new concept in Australia. Compulsory employer contribution had just been legislated. I knew nothing about it.

A family friend nagged me to open a second account (with AMP) ie an account that is not connected to my employer. I remember asking only one question – can I stop contributing if I don’t have the spare cash? Yes, he said, it’s up to you. So I agreed to open an account, knowing I have an escape hatch.

Every year I would contribute about $2000 after tax to this account. I never read the annual statements or cared abut how the money was invested. I just remember that I always resented forking over $2000 or so (it increased by inflation) every year.

All I cared about in my early twenties was saving enough money to go on overseas holidays and eventually buy a house. Retirement was an eternity away.

And yes, I eventually bought a house and had a mortgage. My intention was to pay off my mortgage as quickly as I can. So I stopped contributing to this extra superannuation account. After all, I needed every cent.

But I kind of got used to having debt. Everyone (except my parents) told me that having debt was normal, that some people never paid off their debt until they retire. So it is perfectly ok to travel and live a fine life while paying off your mortgage.

This is exactly what I did. I bought nice things for my house. And travelled overseas. I enjoyed my life. And stopped investing. Duh! This is one of my biggest money mistakes.

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Fast forward to my 40s ...

The year I turned 47, to be exact.

I still remember vividly that morning in January 2018 when I woke up in a cold sweat … I was terrified that retirement was suddenly on the horizon and that I probably hadn’t saved enough to retire at the traditional retirement age. My job was so stressful at the time that the thought of working another 20 years was truly out of the question.

I scrambled out of bed and searched through folders of annual statements to find my account numbers. And set up online log ins. My combined balance from the two accounts was … disappointing. I did not have anywhere near enough to what the retirement experts say you need in retirement.

Fortunately I had just paid off my mortgage. That was the only plus in my favour. Because it meant I have cash to invest in something.

A friend gave me The Barefoor Investor by Scott Pape. In one of the steps, he advised contributing extra to superannuation, up to 15% – ie a top up of 5.5% if your employer contributes 9.5%.

So I decided to ‘do something’ with my super.

Optimising my superannuation

Having two super accounts meant paying two lots of administration fees. So I closed the AMP account and rolled over the balance (minus a hefty penalty) to my main account, REST.

After more reading about industry funds, I chose to roll over to yet another fund (Hostplus) with lower administration fees and the ability to choose index funds to invest in, which lowers management fees even more.

The lower the fees, the more of the investment returns I get to keep.

My next step was to salary sacrifice. That is, I contribute pre taxed dollars to the maximum of $25000 (which also includes my employer’s contribution).

I didn’t have enough time in the 2017-18 financial year to fully achieve this but I did it for the following two years. Because the pandemic affected my returns dramatically, I continued salary sacrificing for the first six months of the 2020-21 financial year.

However this meant that I didn’t have as much as I’d like to invest outside of super.

If I want to retire at 55 (and I really, really, really want to, believe me!), I need to build my ‘bridge the gap’ fund that will support me from age 55 to 60, until I can access my superannuation.

It is a delicate balance between having enough in super to cater for my sunset years (60 years old onwards) and having enough to survive in the five years before I can access super while retired.

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Rule of 72

The Rule of 72 is a quick, useful formula that is popularly used to estimate the number of years required to double the invested money at a given annual rate of return – Investopaedia

I utililised the rule of 72 initially to estimate when I can stop salary sacrificing so much into super.

My reasoning is as follows.

I have 10 years before I can access super. I have an end figure in mind that will support me for the rest of my life from 60 onwards, based on the 4% rule and my expenses.

In order for my balance to double in 10 years, my annual rate of return need to be 7.2% (after fees and taxes).

Is that feasible? I think so.

Despite the tumultuous year of 2020, when my balance plummeted by 30% in March, it has since climbed back up and exceeded all expectations.

The three funds that my super is invested in all returned more than 7% per annum since inception (including 2020). And while past performance doesn’t guarantee future performance, it is a good indication.
 
Therefore I need my super balance to reach the half way mark, with 10 years to reach preservation age. That is, even if I didn’t invest another cent, as long as the average annual growth is 7.2% for the next 10 years, it will grow to my desired final balance.
 
And isn’t that the definition of Coast FI?

 

What ifs?

I’ve done the calculations a million times.

But just in case I got it wrong or the stock market does not cooperate, there are contingencies.

Since I plan to work for the next five years, my employer will be contributing at least 9.5% of my gross salary into my super.

And I am also still salary sacrificing but only less than a third of what I did when trying to contribute the maximum.

I will continue to monitor and review its progress. If the balance is not growing according to plan, I will increase my salary sacrificing again.

The worst case scenario is that I work a couple of shifts a week and not fully retire at 55, contributing all earnings to shore up my super balance.

Or I delay withdrawing from super for a couple of years, if I can survive on funds outside super. The next three years will be crucial in building this ‘bridge the gap’ fund.

So what contributed to my arrival at Coast FI, even as a late starter to FIRE?

(a) That second superannuation account

While I was initially disappointed by the combined value of my super balance, I should be happy with my younger self, on further review.

I calculated at best, I would have contributed around $20k – $25k to this AMP account before I bought my house. I then stopped contributing for at least 15 years. When I checked the balance in 2018, it was a whopping $80k! This was not an industry fund so fees would have been high. And the Global Financial Crisis was smack bang in the middle of it all.

While $80k is nowhere near what I need in retirement, it is good ‘seed’ money and I am grateful to my younger self.

(b) Boosting contributions

Salary sacrificing was tough at times but I am so glad I did it. Those two and a half years boosted my balance so it was totally worth it. There really is no other choice as a late starter. With a shortened time frame, all I can do is throw in as much as I can.

 (c) Investing in low cost funds within super

Looking at my most recent super statement, I paid 0.04% in fees (indirect costs, other fees and administration fees). This means I get to keep more of the investment returns instead of paying others.

(d) The stock market cooperated

While this was totally out of my control, I am grateful that the share market has cooperated! Investing in shares in the long term will pay off one day.

Final thoughts

I wasn’t aiming for Coast FI specifically. And I certainly never believed that Coast FI was possible as a late starter.

But I can tell you that despite all that, arriving at Coast FI is liberating!

I can relax a little, knowing that one phase of my retirement plan has been taken care of.

Now, I’m off to build that ‘bridge the gap’ fund.

And oh, trust in the math!

Have you arrived at Coast FI yet? Did you or will you do anything differently when you achieve(d) the milestone?