I’ve been receiving a lot of feedback from readers lately in regards to the initiation of an emergency fund, and what an appropriate size might be. While everyone has different capital needs based on their monthly expenditures and personal circumstances, one fantastic aspect of dividend growth investing is that the dividends themselves can provide a comfortable margin of safety in one’s monthly budget.
I typically don’t carry around a lot of cash. Cash is one of the worst possible investments one can make because it’s guaranteed to lose value over time due to the ravishing effects of inflation. However, I still like to keep at least few grand in my checking account in case an emergency were to befall me or I lose my job. Life is dynamic and ever-changing, and we aren’t all just investors; we’re people with real lives and sometimes liquidity is a welcome friend.
But I also keep one interesting thought in my back pocket: My dividend income now serves as an emergency fund.
I invest in high-quality companies that have histories of not only paying dividends, but also increasing them on a regular and reliable basis. I’ll one day use this dividend income to pay all of my bills, effectively becoming financially independent. But in the meanwhile, this is is real cash that I can use if the need were to arise.
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- MCD 15-Year Financial Data
- The intrinsic value of MCD
- Peter Lynch Chart of MCD
I think of my dividend income as a “break in case of emergency” source of cash. While I currentlyselectively reinvest 100% of my dividend income, there’s no reason I couldn’t divert this income to my checking account instead and pay bills if I absolutely had to. Now, this is a worst-cast last resort, but the fact that the option is there really takes a lot of weight off my shoulders.
For instance, last month I received $708.83 in dividend income due to my equity positions in a collection of high-quality businesses like McDonald’s Corporation (NYSE:MCD) and Wells Fargo & Co. (NYSE:WFC). While this was no accident and rather a result of hard work over the last four years, this income could be used forwhatever I want. To think I have to reinvest it back into stocks is simpleminded. I certainly plan to continue reinvesting all of my dividend income, and hope I can continue to do so. However, I also know that there’s no requirement. Dividends don’t care what you do with them; dividends are just another income source.
So $709 goes a long way. Based on my expenses last month, I could have paid for my rent, utilities, fuel, car insurance, internet costs, gym membership, pharmacy spending, and my entertainment costs. Not too bad! It’s refreshing and encouraging to know that if I were to lose my job I could have covered a major chunk of my outlay last month. No need to worry about losing the roof over my head.
I often think about what bills I could cover with my dividend income, because ultimately that’s the aim of my investment strategy: I want to one day be able to cover 100% or more of my monthly expenses via dividend income. And I hope that once I’m able to do so, the spread between dividend income and expenses will only widen over time as the dividends grow faster than the rate of inflation and/or the rate at which I increase my spending.
Due to my dividend income now becoming relatively sizable, I feel like it’s less necessary to have a significant chunk of cash on the balance sheet. I often read of people with tens of thousands of dollars in cash sitting around in case of an emergency, and I wonder to myself if these people have ever heard of dividend growth investing. It strikes me as unnecessary to have twenty thousand dollars in cash sitting idle when you may be receiving thousands of dollars in positive cash flow from high-quality businesses.
Of course, it speaks to the necessity to invest in great businesses that have generally good prospects at continuing to pay and raise dividends for the foreseeable future. It also speaks to the importance of diversification. I’ve personally invested in 46 great businesses because there’s always a chance that one or more may see significant changes in operations at some point the future which would require a dividend cut or elimination. If you’re living off of your dividend income, or relying on it as a sort of an emergency source of cash flow, you want to make sure this income is as secure as it can possibly be.
While I’m not recommending to go off and start spending your dividend income, I encourage you to keep in mind that this is an income source that’s just as flexible as any other income source. It’s due to my desire to retire so young in life as well as to maximize flexibility that I’ve decided to keep 100% of my equity investments housed in a taxable account, and as such all of my dividend income is available for me to tap at any given time. I can’t tell you how fantastic it is to know that thousands of dollars every single year is hitting my brokerage account and I could effectively do whatever I want with it. And while I aim to continue selectively reinvesting 100% of this income for years to come until my expenses are exceeded via dividend income on a regular basis, I also know that if an unforeseen life event were to occur which forced me to use this income for bills I could.
And that’s just one more aspect of dividend growth investing I love: The extra dividend income relieves me of the need to store thousands of dollars in cash for emergencies, which I can then invest in high-quality companies that produce rising dividends. This extra invested cash produces more dividends which further increases my income and security. It’s a wonderful cycle!
Dividends just keep getting better and better, don’t they?
Full Disclosure: Long MCD, WFC
How about you? Think of your dividends as an emergency store of income?
Thanks for reading.