Unconventional wisdom: How the ‘typical’ Aussie can gain financial freedom
Franking credits, dividend yield vs growth, and the road to financial freedom.
Conventional wisdom is a byproduct of groupthink that presents solutions good enough for the average person while simultaneously not being right for any individual. You follow it at your peril. Each Monday I will challenge the investing norms that just may be holding you back from living the life you want.
Unconventional wisdom: How the ‘typical’ Aussie can gain financial freedom
“The question isn’t who is going to let me, it’s who is going to stop me.”
- Ayn Rand
There is a growing chorus of investors who are seeking passive income as a means of achieving financial independence. While I applaud these efforts I am surprised with the emphasis on passive income.
Traditionally income investing was the refuge of retirees. Not anymore. According to the ASX Investor Survey 36% of millennial and Gen Z investors have a primary investing goal of generating sustainable income. This is a higher percentage than the overall cohort of employed Australians where 34% list income as the primary goal.
My surprise at the number of young investors pursuing this strategy is not the typical ivory tower disdain for income investing. I’ve been pursuing the same goal since I was in university. My surprise is that so many people are following a similar path.
My plan to leave a terrible job
My first job was boring. So boring that I spent most of my time at work trying to figure out a pathway to something else. I didn’t apply for new jobs. I didn’t upskill. I didn’t try and get promoted. I tried to figure out how to retire early.
My goal was to retire at 50 and my plan was to generate enough in passive income to pay for my life. This seemed like a reasonable life goal – instead of working for a living I would live off dividends.
More about what happened to my plan later. But first, I wanted to see what it would take for the typical 22-year-old Australian to create a passive income stream that would pay for their life. Along the way there will be some important lessons for Australians of any age that are striving for financial independence.
What is financial independence?
Everybody has a different definition of financial independence. Mine is the ability to replace your salary with a passive income stream.
With that goal in mind, I’ve attempted to model out what it would take for the ‘typical’ 22-year-old Australian to replace their salary with passive income.
Along the way I’ve had to make several assumptions that readers may, or may not, agree with. I welcome your feedback. The first of these assumptions for my hypothetical 22-year-old is starting with no savings and no debt.
What is the ‘typcial’ Australian?
The median annual salary exclusive of super for an Australian between the ages of 20 and 24 is $61,895 according to the Australian Bureau of Statistics. Over the past decade wages in Australia have risen 2.4% annually. I have my starting point and a means to project a salary into the future.
The target for the passive income stream is the money left over from a salary after-tax (including the Medicare levy) and after-savings. I will account for taxes in the passive income stream as well to make an apples-to-apples comparison. Savings won’t be needed once my hypothetical 22-year-old is ‘financial free’.
I’m starting with a baseline savings rate of 10% of after-tax earnings. I acknowledge that is a high saving rate when you are young and trying to pay for the essentials on a low salary. But financial freedom isn’t free – our hypothetical 22-year-old needs to be a penny pincher.
The following chart shows the target for financial independence. To spare readers a large chart I’ve provided the starting point and then five-year increments until our hypothetical 22-year-old turns 60.
Building a passive income steam
I am not even going to consider fixed interest or cash. You just can’t get to the levels of passive income needed without growing dividends unless you have a great deal of money. Our hypothetical 22-year-old is starting from scratch.
When building a passive income stream from dividends there are several inputs that matter:
Dividend yield
The dividend yield determines how much income you can purchase with your savings. It also indicates how much passive income you can purchase by reinvesting your dividends.
I’m assuming the yield stays flat over time. In this scenario the share market will appreciate at the same rate as dividend growth to maintain a consistent yield.
Dividend growth rate
The growth rate of dividends over time matters. This is an important component of growing passive income along with new savings and dividend reinvestment.
Taxes
One of the issues with dividends is that they are taxed when they are paid. My observation is that many income investors ignore taxes when modelling out future scenarios. This is often because dividends are reinvested, and taxes are paid out of separate savings.
This is mental accounting trick that I don’t want to include in my model. I will simply reduce the passive income by the taxes paid while including the benefit from franking credits. Anything left over will be reinvested.
Two dividend investing scenarios
I am going to create two scenarios for dividend yields, dividend growth rates and taxes.
Aussie, Aussie, Aussie
I will start with the Aussie, Aussie, Aussie scenario. Australia has some of 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.
This makes sense as the 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.
In the Aussie, Aussie, Aussie scenario I’m assuming a dividend yield of 4.10% excluding franking credits and a yield of 5.50% including franking credits. According to Australian market commentator Ashley Owens that is the average ASX dividend yield this decade.
In the decade up to 2022 the Australian dividend pool grew at a compounded annual growth rate (“CAGR”) of 4.78% according to S&P Global. I will use that figure as an estimate for dividend growth.
The aristocrats
Next is the aristocrat scenario. The dividend aristocrats are a group of US companies that have raised their dividends for 25 consecutive years. Currently they are yielding 2.30% which seems low from an Australian perspective but is higher than the current 1.30% yield of the S&P 500.
Over the past decade the 69 members of the dividend aristocrats have raised their dividends at a CAGR of 7.20% according to ETF provider ProShares.
Reaching financial independence
I first put the Aussie, Aussie, Aussie scenario through the paces. Passive income growth was fuelled by new savings, increased dividends and dividend reinvestment. Growth was slowed by taxes which were offset by franking credits.
I’ve added a column to the initial chart which shows total post-tax passive income generated and included an additional row at age 44 which is when our hypothetical investor reaches financial freedom. More on the lessons later.
Things did not work so well for our investor in the aristocrat scenario. At no point did the hypothetical investor reach financial freedom. Below is the total post-tax passive income generated at each of the milestone ages.
Lessons
There are several reasons things worked out well for the Aussie, Aussie, Aussie scenario and not so well for the aristocrat scenario. In order of impact they were as follows:
Tax / franking credits
Our hypothetical 22-year-old had a low marginal tax rate of 30% applied to dividend income for many years. At that low marginal tax rate the franking credits exceeded the tax on dividend income.
Not only did this completely offset any tax on dividends it also added additional funds that could be reinvested to further grow the passive income stream. Eliminating taxes and having additional funds to invest early in the scenario turbo-charged compounding.
After our hypothetical income investor moved to higher marginal tax rates the franking credits still offset a meaningful percentage of the tax on dividends. This made a significant difference as the effective tax rate (including franking credits) on passive income was much lower than the effective tax rate on wages. As I was comparing post-tax income levels it hastened financial independence.
If I remove franking credits from the Aussie, Aussie, Aussie scenario our hypothetical income investor never reaches financial independence. The total passive income earned at age 60 is $1,734. Conversely, if I added franking credits into the aristocrat scenario financial freedom was achieved at age 47.
The combination of dividend yield and dividend growth matters
Dividend yields are lower globally than in Australia. However, it is easy to find global shares with yields that exceed the 2.30% that I used in the aristocrat scenario. Out of the 69 dividend aristocrats 15 of them have a yield higher than 3.50%.
The key is balancing yield and dividend growth. Where that balance falls depends on the length of your investment timeline. Longer time frames put more of an emphasis on growth while shorter time frames favour yield.
If franking credits were included in the aristocrats scenario financial freedom would have been achieved three years later than the Aussie, Aussie, Aussie scenario. However, at age 60 the higher dividend growth rate would have had more time to play out.
At age 60 the scenario where I included franking credits in the aristocrat projection the total after tax income would have been $304,491 vs. $207,796 in the Aussie, Aussie, Aussie scenario.
Ideally a portfolio combines some assets with high yield 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.
Was this realistic?
It is difficult to imagine many 22-year-olds following the scenario I laid out in this exercise. The savings levels were high for someone starting out on a low salary and I left no room to save for anything else including an emergency fund, a house or any other goal.
The difficulty in imagining this scenario is the reason many dedicated investors never generate sufficient levels of passive income to completely replace their salary. When saving for multiple goals it is likely a higher salary would be needed to support a higher savings rate to even imagine achieving this form of financial independence prior to retirement.
Final thoughts
The 2024 Stake Ambition Report provides some interesting context to the passive income goals of younger generations. The Stake report outlines the differences in generational attitudes to the role investments and wages play in life. The following chart from Stake illustrates those differences.
Source: 2025 Stake Ambition Report
In the projection I ran on generating a sufficient passive income stream to gain financial independence there are many variables that can be adjusted to hasten or slow this journey. Many investors – including me - aim to find better trade-offs between yield and income growth. This is difficult to do but a worthwhile goal.
However, the number we should be most concerned about is the 2.40% wage growth in the last decade. This is below inflation and indicates that the average Australian is seeing their lifestyle drop.
Perhaps this is what has led to the perplexing survey results from Stake. Baby Boomers who are overwhelmingly retired and live all their assets cite career progression as the pathway to building wealth. Gen Z with their whole careers ahead of them and few assets favour investing.
I understand the impulse of dismissing future wage growth as way to build wealth. Back in my early career days of cubicle confined monotony the scenarios I ran to escape the daily grind reflected the same view. What I couldn’t see back then was how my priorities and perspective would change over time.
As I advanced in my career it became more interesting and fulfilling. As my salary rose and my experiences broadened it opened my eyes to more of what the world offered. I was no longer willing to just get by after meeting some minimal level of passive income. Wage growth matters as long as savings rates also grow and lifestyle creep doesn’t take over.
What is so powerful about saving and investing is the ability to turn sacrifices when you are young into options when you are older. That is what I’ve learned from my own passive investing journey. I no longer have the desire to retire at 50 but that doesn’t mean my decisions when I was younger are not improving my life today.
If you are in Brisbane come hear Shani and I speak at the Queensland Investors Club on November 11th.
Email me at [email protected] with your thoughts.
Shani and I have a favour to ask
Our book Invest Your Way was released on the 8th of October. A big thank you to everyone who ordered a copy in presale.
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Invest Your Way is a personal finance book that combines foundational investing theory, real-world application and our own experiences. It is designed to help readers create a financial plan and investing strategy that is tailored to their unique goals and circumstances.
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What i’ve been eating
There is no shortage of great bakeries in Surry Hills. Rather than select a single bakery to frequent I’ve taken the economic notion of comparative advantage and applied it to the various options. I go to Lavie & Belle for baguettes, Humble for sourdough batards and Avner’s for bagels.
Rumour has it that bagels were invented in response to an antisemitic law in Poland that banned Jews from baking bread. Bagels are boiled first and then baked. Ingenious loophole to circumvent a law? Good origin story? Who knows. Bagels came to the Lower East Side in Manhattan in the early 1900s and growing up outside of New York a century later I became a bagel snob. Too many bagels and fluffy and bready. Not at Avener’s where they are perfectly dense and chewy.
