Can passive income replace your salary?
In this episode of Investing Compass, we run through what it would take for an average Aussie to replace their income.
In this episode, Mark and Shani test whether a typical young Australian investor could realistically achieve financial freedom through dividend income.
Using real-world assumptions around salary growth, savings rates, dividend yields and taxes, they model two investment portfolios to see how long it would take for passive income to replace a full-time salary.
Read the full article here.
A few more resources on passive income:
Reaching six-figures in passive income is not easy but don’t underestimate the benefit of time in the market.
Many investors seek to build passive income. Learn some strategies for growing passive income over the long-term.
A metric that can improve your results as an income investor.
Our free tool can help investors that dream of living off of passive income.
The growth of passive investing has stimulated academic and policy interest in how it affects asset prices and the real economy.
You can find the transcript for the episode below:
Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situation, circumstances or needs.
Mark LaMonica: Well, Shani, in a blast from the past, you have recently been making fun of me for something that I think happened six years ago, somewhere around then. And it was, I was wearing a blazer one day at work when I actually cared about my appearance more. And one of our colleagues made fun of it. She said that her grandmother had the same jacket.
Jayamanne: It was very funny, I think especially because her delivery was quite deadpan.
LaMonica: Yeah, you thought it was very funny, but I’ve never worn the jacket again. So I basically did what most men with no confidence do when they’re made fun of.
Jayamanne: Yes, I guess so.
LaMonica: So, all right. The point of the story is simply to say that you think I’m over the hill and hopelessly out of touch with young people. But that is actually not the case because recently I discovered that I’m a trendsetter.
Jayamanne: I mean, I’m really no position of authority to speak about this because I’m definitely not a trendsetter. I’m hopeless.
LaMonica: Well, I am. So I can tell you about it.
Jayamanne: Let’s see where you’re going with this.
LaMonica: Okay. The ASX Investors Study Survey, so they put that out every year. So they asked different cohorts of investors their primary investing goal. And one of the answers that people could select was to generate sustainable income. 36% of millennial and Gen Z said that that was their primary goal. And that is higher than the average of all investors, which is only 34%.
Jayamanne: And that is quite strange because typically investors don’t turn to income until later in life.
LaMonica: Yes, but when did I start investing for income?
Jayamanne: Very young.
LaMonica: University. So hence me being a trendsetter. But when I saw this data, I tried to figure out what it would take for the typical young Australian to gain financial freedom. But I think this is going through this exercise also has lessons that are applicable for investors of any age.
Jayamanne: All right, Mark. So let’s start with the basics. How do you define financial freedom?
LaMonica: Well, it’s a difficult one to define. We wrote a whole book trying to talk about financial freedom. And I think the point that we made is that it’s, of course, a journey. And so you slowly get there by degrees. But for the purpose of this podcast, and considering that renewed interest in passive income, we’re going to consider today financial freedom is making enough in passive income to replace a salary.
Jayamanne: The dream.
LaMonica: Exactly. Exactly.
Jayamanne: And to go through this exercise, we do need to make some assumptions. The first is the starting point for salaries. The median salary for an Australian between the age of 20 to 25 is $61,895. Exclusive as super, according to the ABS. We’re also going to assume that that wage growth from the last decade continues into the future.
LaMonica: And as I think a lot of listeners are probably aware, that wage growth is not great. So it’s only 2.4% annually. So there are a couple other assumptions we need to make. The first is our hypothetical investor is saving 10% of after tax and after super salary. And that after tax component includes the Medicare levy.
Jayamanne: And we both admit that is a lot and potentially unrealistic. But the point of this is to see what it would take to achieve financial freedom.
LaMonica: The other important part of modeling this out is the amount of passive income an investor can generate with those savings. So I created two different portfolios, Shani. And the important thing for this simulation and for any income investor to try to figure out how much you can make is the dividend yield, dividend growth rate and taxes.
Jayamanne: And these inputs will determine how much income comes from new savings and dividend reinvestment and how much an income stream will grow.
LaMonica: All right. So we need figures for all of those. So as I mentioned, I did create two different portfolios.
Jayamanne: And you creatively named them.
LaMonica: I’m very creative. Not only a trendsetter, but also creative.
Jayamanne: So the first one was called Aussie-Aussie-Aussie.
LaMonica: Yes, because that’s what you people like to yell at cricket matches and different venues.
Jayamanne: Okay. So what are the assumptions with that one?
LaMonica: Okay. Well, so unsurprisingly, this is a portfolio of Aussie shares. So during this decade, the average dividend yield of Aussie shares was 4.10%. So that is excluding franking credits. And then if we include franking credits, it’s 5.50%.
Jayamanne: And Australia has some of the highest dividend yields in the world and the added benefit of franking credits. These benefits don’t come without a trade-off, and dividend growth is typically lower. So this makes sense as a less money a company reinvests in the business, the lower the earnings growth. Since dividends are paid out of earnings, dividend growth will be lower as well.
LaMonica: And we see this in the decade up to 2022. The Australian dividend pool grew at a compounded annual growth rate of 4.78%, according to S&P Global. So I’ll use that figure as an estimate for dividend growth.
Jayamanne: All right. And what’s the second portfolio?
LaMonica: I named this one the aristocrats, which is how I felt wearing my blazer, but other people disagreed. So the dividend aristocrats are a group of U.S. companies that have raised their dividends for 25 consecutive years. So currently, this list is yielding 2.30%, which does seem really low from an Australian perspective, but it is higher than the yield of the S&P 500, which is 1.30%. Over the past decade, the 69 current members of the dividend aristocrats have raised their dividends at a compounded annual growth rate of 7.20%, according to ETF provider ProShares.
Jayamanne: Okay. So now that we have the base down, we can run the simulations. And I was there when Mark was putting together this spreadsheet, and there was a lot of frustrated noises coming from his seat.
LaMonica: Frustrated noises. Okay. Well, it wasn’t the easiest thing in the world to do because of all the taxes. And I think a lot of the frustration was, I always forget the Medicare levy. And Shani apparently thinks about the Medicare levy all the time. So after I created the spreadsheet, I had you come over and I was showing it to you, and then you were like, you forgot the Medicare levy. So that was where some of the frustration was coming from, but the article I wrote generated what I would call a moderate amount of interest. So I don’t know if it was worth it.
Jayamanne: They can’t all be top performers, Mark.
LaMonica: Yeah, or in my case, most articles I write. But let’s get into the results of this simulation we ran. So we started the Aussie-Ausie-Ausie portfolio. So passive income growth was fueled by new savings, increased dividends and dividend reinvestment. Growth was of course slowed by taxes, including that Medicare levy. But that was also offset by franking credits.
Jayamanne: And our hypothetical 22-year-olds was unable to meet financial freedom, but came close at 60. So what do you think about that, Mark?
LaMonica: Yeah, I mean, the goal obviously was to or the hope was to reach financial freedom before 60, because obviously that’s preservation age. But I don’t know, I think it’s pretty good, because that investor would have over, and this is after tax, over $87,000 of passive income. As they hit 60. So even if they just retired then, they’d have their super its not too bad.
Jayamanne: That’s pretty good. That’s pretty good. But things did not work out so well for our investor in the aristocrat scenario. Once again, at no point did the hypothetical investor reach financial freedom. At 60 years old, the investor would have about $30,000 after tax income.
LaMonica: And it is meaningfully less than the Aussie-Ausie-Ausie scenario.
Jayamanne: Yeah, so those are starkly different outcomes. What happened?
LaMonica: Yeah, well, I think the first lesson is franking credits and taxes matter. So our hypothetical 22-year-old started at a low marginal tax rate, so 30%. So that was applied to dividend income for many years. And at that low marginal tax rate, the franking credits actually exceeded the tax on dividend income. So not only did this completely offset any tax on dividends, it also added additional funds that could be reinvested, which further grew that passive income stream. So eliminating taxes and having additional funds to invest early in the scenario, eventually turbocharged that compounding.
Jayamanne: And after our hypothetical income investor moved into a higher marginal tax rate, the franking credits still offset a meaningful percentage of the tax on dividends. And this made a significant difference in the effective tax rate, including franking credits, on passive income, which was much lower than the effective tax rate on wages. Since the simulation, it was comparing post-tax income levels, it hastens financial independence.
LaMonica: The next lesson is related to the relationship between dividend growth and dividend yield. So dividend yields are lower globally than in Australia, as Shani said earlier. However, it is easy to find global shares with yields that exceed that 2.30% that was used in that aristocrat scenario. So out of the 69 current dividend aristocrats, 15 of them have a yield higher than 3.50%. And I think we talk about this a lot. The key is balancing yield and dividend growth and understanding that trade off. So where that balance falls depends on the length of your investment timeline. So if you have a longer timeframe, but more emphasis on growth, shorter timeframe yield probably makes more sense.
Jayamanne: So ideally, a portfolio combines some assets with high yields and lower growth, and some with higher growth and lower yields. Given franking credits, it makes sense to have the higher yields in Australian shares and higher growth in global shares. Now, as we said, we aren’t sure that this situation is realistic. This would be very hard for an investor to concentrate solely on passive income given those savings levels. This means foregoing any other goal you might be saving for, including an emergency fund, a house, anything else. But the exercise is still worthwhile, I think.
LaMonica: The next question is what is going on with younger generations? Now, typically we’d ask you, Shani, but since I’m the trendy one, I can talk about it. So I think one thing is that we see from additional survey results is that perhaps millennials and Gen Z are spending too much time making fun of people for strong fashion choices, like my blazer, and they should be spending time working on their finances. And we saw this in the, not the fashion part, but we saw this in the 2025 Stake Ambition Report. So it’s a report that Shani, you were in, and our colleague, Sim, was in, which was great. But what this does, what this report does is it provides some context to the passive income goals of younger generations. So the Stake Report outlines the differences in generational attitudes to the role investments and wages play in life.
Jayamanne: And interestingly enough, Gen Z millennials, Gen X and boomers were asked if investing assets made more of a difference in getting ahead financially than career progression. And the results were a little bit surprising. So 70% of Gen Z said that financial assets were more important than career progression. 69% of millennials agreed, 57% of Gen Z and 47% of boomers.
LaMonica: Yeah, which is interesting because most boomers at this point are retired. Obviously, they’re looking back on their experience. But I think probably a big reason for this is that number we talked about in the beginning, that 2.40% wage growth over the last decade. So that is below inflation. And so that of course indicates that the average Australian is seeing their lifestyle drop.
Jayamanne: And that makes the results from that Stake Report more understandable. And why so many young people are dismissive of future wage growth as a way to build wealth.
LaMonica: And wage growth is still critical to getting ahead because as we said, that 10% savings rate is really difficult to do when you are young and on a low wage. So wage growth matters as long as of course, when you’re making more money, that your savings are growing and you don’t just let lifestyle creep take over. So I think that that’s the real example for this that while these two hypothetical scenarios did not result in financial freedom, if you can upscale, increase your salary, save more money, you can actually get there. So saving higher than that 10% after tax after super rate. So that is our podcast for the day. We’ve had some good fashion advice, which I guess is don’t dress like me. And we appreciate everyone listening.
(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)
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