One of my friends who knows that I run an investing website recently offered this insight to me as part of a casual conversation we had (and this is my paraphrase of what he said): It seems to me that the kind of people who would do really cool things with money are broke because they are completely incapable of sitting still and letting something build, and the kind of people who can build great wealth are so boring and frugal that they never put the money to any fun use.
There’s probably some truth to that—the statistics show that the average American is far, far away from being able to generate significant dividend income to have some fun in a way that receiving growing thousand-dollar dividend checks permits, and the traits that lead to wealth accumulation generally aren’t consistent with the traditional American image of “living it up.” When I get an e-mail from a man with $3,500,000, no wife, and no kids, and he is worried about having enough money to last the rest of his life, I don’t really know how to react. It’s not a judgment, but rather, my own wondering about what dollar amount (either in passive income or net worth) would be required to make the person feel secure.
It’s been an emerging theme here on the site, and perhaps it is only applicable to the people who regularly read sites like this rather than for people situated with the savings of the “average American”, but there is something to be said about living off the dividends as you go through life if you ever find yourself in a situation where it looks like you are somewhat overfunded.
For instance, I heard from a young woman whose parents died and she found herself sitting on $460,000 in an S&P 500 Index Fund. She recently graduated from college, putting her in the 23, 24, 25 age range, and she had a job paying $36,000. The conventional advice, like you’d see in Kiplinger’s or something, would tell you to keep reinvesting the dividends and then look at what you have when you are sixty-five years old.
That is a strategy for maximizing wealth, but it is not a strategy for maximizing the utility of money.
The money is with Vanguard, and there’s no need to sell it, so why not collecting the $9,000 annual dividends each year, and let the rest compound? There are three ingredients to wealth creation—you get your dividends, and there is also the growing profits which increase your paper wealth as long as the valuation increases proportionately. When you collect dividends, you are still leaving your wealth-building engine intact; you’ve got the five-hundred leading Western companies growing their profits so that you’ll get something resembling dividend growth, and your net worth should double every seven years or so. Even if she gets 7% returns for the next thirty-five years by taking out the dividends to live on, she will still end up with $5.2 million by her sixtieth birthday. She doesn’t need reinvested dividends to meet retirement goals—plain old growth and the rising prices that naturally accompany it will give her a great life outcome.
Meanwhile, that $9,000 in current income will give her an extra $750 to spend each month. That has real utility in terms of improving your standard of living when you are bringing in $3,000 per month. By living on dividends throughout her life, in conjunction with what she makes from her work, she can build wealth even while she may seem to be living above her means and spend $3,750 each month.
Having $9,000 per year extra as a twenty-something has tremendous use over mindless compounding that treats life like a video game in which you receive some kind of prize for being the richest man in the cemetery. It doesn’t work that way—I realize this is only applicable to a very, very small subsection of America, but if you are well ahead of where you need to be savings wise by any conceivable metric that uses very conservative assumptions, then you might look back on your life more fondly if you took that extra vacation, went to that extra ballgame, or spent that extra thousand dollars even if it goes against your usual savings habits.
Originally posted 2014-12-24 08:00:40.