Whether you’re just starting out your career or nearing retirement, the idea of stockpiling an investment portfolio to generate a passive income might be intriguing.

But how much money do you realistically need to be able to drop out of the workforce and get by on dividend payouts alone?

While you will have to start by honestly assessing what you can live with — and without. But there’s a simple formula and some less simple risks you’ll need to consider when making the big dividend-dependency decision.

Dividends are great tools for investors

Dividends are payments made by publicly traded companies to their shareholders. They’re typically used to communicate strength about the company’s financial position. Steady dividends — even low ones – often signal a company’s positive projection of its long-term outlook.

Many dividends are paid in cash. For investors with 401(k)s or IRAs, dividends are often automatically reinvested and, through the power of compounding, offer a powerful tool to grow a nest egg.

For straight-up equity investors, those cash payouts fuel dividend income — where passively generated payouts cover your living expenses.

How much you’ll need

How much you’ll need exactly depends on your income, spending habits and living expenses. Which means the answer is highly personal.

But once you know how much you’ll need to live, here’s a simple formula to apply that to sort out how much you need in total.

Desired Dividend Income / Dividend Yield (%) = Estimated Portfolio $ needed

Let’s consider a desired dividend income of $40,000.

The average dividend yield of the S&P 500 is currently around 1.4% to 1.6%,

Using our formula mentioned above, here’s how yields translate to required portfolio size:

$40,000/1.5% = $2,666,667

A Better Strategy

We spoke in a previous article about the 4% rule, Which is the idea of selling 4% of your portfolio year after year.

Assuming your portfolio is $2,555,557, you will be able to sell $106,667 on the first year and if your portfolio continues growing at a rate of 8% per year, you will be able to take more money out more money the following year.

Or assuming that all you need is $40,000, then, using the 4% rule, all you need is $1,000,000.

Other personal finance blog posts

• Annuities vs. the 4% Rule: The Better Way to Retire Comfortably
• The Hidden Power of Incentives: How They Shape Our Choices and Actions
• The Price of Living Your Own Life Is Letting Go of Others’ Approval