Many Australians dream of Financial Independence – t he idea of covering living costs without a nine-to-five job is appealing. But how do you fund it?

Some people fund FIRE (financial independence, retire early) through dividends, while others sell shares or other investments over time. One provides passive income, the other draws from a portfolio. Both have pros and cons – neither is the perfect solution for everyone.

This article explores both approaches – how they work, their potential benefits and risks, and what to consider when planning for FIRE.

Living off dividends: a passive income strategy

Some FIRE investors aim to fund their lifestyle through dividend income – regular payments from shares, exchange-traded funds (ETFs), real estate investment trusts (REITs), or listed investment companies (LICs). Instead of selling shares or other assets, they rely on passive income to cover living costs. This approach appeals to those who prefer stability and want to avoid managing withdrawals.

Types of dividend producing investments

Dividend-focused investors tend to hold:

• Dividend ETFs – These funds invest in companies known for paying consistent dividends, potentially offering diversification.
• REITs – These invest in property and pay out rental income as dividends.
• LICs – Actively managed funds that invest in dividend-paying shares and distribute any net profits.
• High-yield shares – Companies with a history of paying reliable dividends, often from sectors like banking, utilities, or consumer staples.

How does the dividend strategy work?

The core idea is to build a portfolio of income-generating investments and live off the dividends. Investors typically follow these steps:

1. Invest in dividend-paying assets – This includes shares and other investment types listed above that seek to regularly distribute earnings.
2. Reinvest dividends before retirement – Compounding can help grow the portfolio faster, and could increase potential retirement income.
3. Live off dividend payments – Once FIRE is reached, dividend income replaces ordinary income (acting as a pension), funding daily expenses.

Some investors prioritise fully franked dividends, which come with tax credits that can offset personal income tax, subject to their tax bracket. This can be beneficial, especially for retirees on a lower ordinary income . It’s wise to see a tax professional to understand how this works.

What to keep in mind

Dividends provide passive income, but they’re not guaranteed. Companies can reduce or cut payments, particularly during economic downturns, like a bear market. Unlike reinvested profits, dividend payouts can also limit long-term capital gains growth.

Selling investments: a capital withdrawal strategy

FIRE investors may choose to fund their retirement by selling investments over time. Instead of relying on dividends, they gradually withdraw from their portfolio as income to cover expenses. This approach offers flexibility but requires careful planning to ensure funds last throughout retirement.

How does the capital withdrawal strategy work?

The goal is to build a portfolio large enough to withdraw a set percentage each year without depleting it too soon. Investors typically follow these steps:

1. Invest in a diversified portfolio – This includes ETFs, shares, and other assets to balance growth and stability.
2. Follow a structured withdrawal plan – Many investors start with the 4% rule, adjusting their withdrawal rate based on market performance and personal needs.
3. Manage withdrawals over time – Selling investments strategically can help maintain capital while funding retirement expenses.

What is the 4% rule?

The 4% rule suggests withdrawing 4% of a portfolio annually, adjusting for inflation . This method assumes a mix of shares and bonds can sustain withdrawals for at least 30 years. While popular in the US, some Australian investors generally use this withdrawal rate as a guideline rather than a strict rule.

What to keep in mind

Withdrawals may need adjusting based on investment returns, inflation, and lifestyle changes. For instance, selling investments during a market downturn can reduce long-term capital growth. Some investors keep a cash buffer to avoid selling at a loss.

This strategy offers flexibility but requires ongoing management. Investors need to plan for changing expenses, market fluctuations, and how long their capital will last.

How do the investment strategies differ?

Both strategies aim to fund FIRE, but take different approaches to building and using wealth. Each has distinct investment priorities and risk considerations.

Considerations for a dividend strategy

• Focuses on dividend-paying shares, ETFs, REITs, and LICs. This can lead to a concentration in sectors like banks, utilities, and infrastructure.
• Prioritises income over capital growth, which may impact long-term portfolio performance.
• Relies on companies consistently paying dividends, so income can fluctuate based on market conditions.
• Like a pension, it offers less flexibility, as investors depend on payouts rather than choosing when to withdraw funds.

Since dividends are not guaranteed, this approach may require diversification and a backup plan for years with lower payouts.

Considerations for a capital withdrawal strategy

• Invests in a diversified portfolio of growth and income-producing assets, balancing risk and return.
• Designed for long-term capital growth, with withdrawals structured to sustain retirement income over decades.
• Allows investors to adjust withdrawals based on expenses, inflation, and market conditions.
• Requires more active management, as investors need to decide when and how much to sell.

As with any investment strategy, outcomes depend on market performance, economic conditions, and personal circumstances. No approach guarantees financial security.

What are the pros and cons of each strategy?

Both strategies offer potential benefits and drawbacks. The best choice depends on personal preferences, risk tolerance , and financial goals.

Dividend strategy

Pros	Cons
Regular income – Dividend payments provide cash flow without needing to sell shares. Less reliance on market timing – No need to decide when to sell shares. Impact on tax rate – Franking credits may reduce the tax rate, depending on an investor’s personal income tax bracket. Capital remains invested – High-performing assets may still grow in value while generating income.	Dividends aren’t guaranteed – Companies can reduce or stop payments, especially during downturns. Lower capital growth – Some dividend-paying shares prioritise payouts over reinvestment. Sector concentration risk – Dividend-focused portfolios may be overweight in banks, utilities, and real estate. Less flexibility – Income depends on company payouts rather than personal withdrawal choices.

Capital withdrawal strategy

Pros

Cons

Greater flexibility – Investors control how much to withdraw based on their needs. Broad diversification – Portfolios can include a mix of growth and income-producing assets. Higher potential capital growth – Growth-focused investments may increase net worth over time. Adjustable withdrawals – Spending can be adapted to market conditions or lifestyle changes.

Market risk – Selling investments in a downturn may reduce long-term capital. Ongoing management – Investors must plan withdrawals to avoid running out of funds. Tax treatment – Selling investments with long-term capital gains may trigger capital gains tax to pay to the Australian Taxation Office (ATO), depending on the asset and holding period. Sequence risk – Poor market performance early in retirement can impact long-term sustainability.

Both approaches have trade-offs. The dividend strategy aims for stability but depends on company payouts. The withdrawal strategy offers flexibility but requires careful planning to maintain capital over time.

Some investors combine the two strategies, using dividends as a base income and withdrawals for extra flexibility. To decide the right strategy for you, you might want to seek professional advice from a qualified financial adviser.

Case studies: two investors, two approaches

No FIRE journey is the same. These fictional examples show how two investors, Theo and Liana, use different strategies to fund retirement.

Case study 1: Theo – Living off dividends

Theo builds a portfolio of high-yield ETFs, LICs, and REITs over 20 years. His goal is to generate enough dividend income to cover expenses without selling investments.

By the time he reaches retirement, his annual dividends fully cover his spending. He benefits from franking credits, which reduce his income tax liability. Because he doesn’t sell assets, he avoids triggering capital gains tax.

But dividends aren’t guaranteed. If companies cut payments, his net worth may remain stable, but his income could fall. To prepare, Theo keeps a cash buffer in his emergency fund to cover shortfalls.

Case study 2: Liana – Selling investments

Liana invests in a mix of ETFs and shares, focusing on long-term capital gains. She doesn’t rely on dividends but follows a structured capital withdrawal plan.

In retirement, she sells shares in her portfolio each year, using the 4% rule as a guide for her withdrawal rate. This gives her flexibility in managing expenses. Since some assets have grown significantly, she pays capital gains tax when selling. However, she spreads withdrawals over multiple years to stay in a lower tax bracket for income tax purposes.

Liana’s main challenge is market volatility. Selling investments during downturns can reduce her net worth, especially if asset prices remain low. To manage risk, she holds a cash reserve, reducing the need to sell during market dips.

These examples are hypothetical and not financial advice. Returns are not guaranteed, and both strategies come with risks and tax considerations, including paying personal income tax and capital gains tax to the ATO . Impacts vary across each tax bracket so consider seeing a tax professional to understand how different scenarios may affect your financial position.

Which makes more sense for your FIRE?

Reaching Financial Independence is more than picking a strategy – it’s choosing one that fits your goals, risk tolerance, and lifestyle.

Some people value the stability of dividends, while others prefer the flexibility of capital withdrawals. And some take a hybrid approach by using dividends as a base and selling investments when needed.

Rather than focusing on the “right” choice, consider what’s important to you. Do you want retirement income that feels predictable? Or are you comfortable selling investments when needed to maximise long-term capital growth?

Though there’s no perfect answer, there is a next step. Take a closer look at your portfolio, do the numbers, and see what aligns with your financial goals. A financial adviser can help you with this.

FIRE isn’t just about reaching independence – it’s about maintaining it in a way that suits your lifestyle.