The Power of Dividends - How Dividend Investing Can Make You Rich
Dividend investing will make you rich. Not only that, it will replace your income overtime so you no longer have to work. The key is to start now. I'll show you just how powerful dividend investing can be in your financial life.
I'm a huge fan of dividends. You already know this if you read my article 15 Ways to Create Passive Income. There is no other form of income that is more passive than dividend income.
I would even argue that winning the lottery is less "passive" than dividends. You at least still need to go buy the ticket.
With dividends, however, you can just automatically deposit into your investment account, set up corresponding automatic investments, which will in turn, automatically raise your dividends. Nothing beats an automatic raise every paycheck!
Just imagine replacing your working income with passive dividend income. How freeing would it be to know that cash will come in every single quarter and it will automatically increase each time?
Sounds impossible doesn't it? I'm here to tell you it's more than possible. You have to remember that every dividend paying stock has a real company behind them producing real products and services.
If a company is routinely paying and increasing their dividend, then they probably have some sort of long term competitive advantage that drives real value to it's owners.
Warren Buffett is famous for an expression he uses about why he doesn't invest in gold; "If I owned all the gold in the world and had it in one place it would be about the size of a baseball diamond and about 6 stories tall. I could caress it, talk to it, touch it, and see it, but at the end of the day it's just a big piece of gold that doesn't produce anything or create any real value. Businesses on the other hand are out there creating something and adding value to society. I would rather own the business."
That's not word for word how he said it, but that is the general gist of his expression and I couldn't agree more.
I personally collect my dividends from a few different sources. I'm invested in Vanguard's S&P 500 ETF and their Real Estate Investment Trust ETF, as well.
In addition, I own several dividend paying stocks. I'm a big fan of self storage and lucky for me there are several self storage focused public companies out there, otherwise known as REITS (I'll get into REITS in another article).
I own EXR, PSA, CUBE, NSA, LSI, and SELF. These stocks may not be appropriate for you and this is not investment advice, but I believe in the long term economics of self storage and think these are fantastic companies.
At the time of this writing, they all yield over 4%. That's pretty good considering this low interest rate environment we are currently in. This also fits within my goals.
One of my long term goals is to earn over $100,000 per year in dividend income based on a 4% dividend yield. I choose 4% because I believe you can achieve a 4% dividend yield very safely and it's a conservative number.
Again, these particular stocks may not be the right fit for you, but I believe that the future of self storage is bright and I never sell my investments. Self storage companies are cash flow machines and I believe they will be paying out over the next 40 to 50 years without any concern. That's the only investment thesis I need.
That brings up another point on dividend investing. It's important that you find balance when searching for dividend investments. In other words, don't invest in the highest yielding stocks you can find.
There are some good ones out there and some bargains, but generally speaking if a stock has a significantly higher dividend yield than the rest of the market and companies within it's industry sector, there's probably a reason for that.
It probably means that the underlying economics of that business is deteriorating and the market expects that dividend to continue falling, as well as the stock price. You should look for companies that have a history of increasing dividends, but still maintain a conservative dividend payout ratio.
The dividend payout ratio just represents the amount of their annual income that is distributed out in the form of dividends. So, if a company earns $100 in a year and pays out $60 in the form of dividends, then their payout ratio is 60%.
Using that same example, if a company paid out $99 of their $100 in earnings, then there is not much room there for the dividend to grow moving forward. That company is probably going to have to raise capital else where to fund growth or lower their dividend to fund future growth.
An easy and passive way to start growing your dividend portfolio is to invest in dividend funds or factor ETFs. There are funds out there that track indexes of dividend paying stocks.
Take a look at Vanguard's Dividend Appreciation Index Fund as an example (VDAIX). Not only is this a quick and efficient way to get started, but you automatically achieve a level of diversification that you otherwise could not on your own.
Sure, you could go buy all the stocks in that index, however you cannot do it as cheaply as the fund that already does it. A huge mistake that investors make is to forget about transaction costs.
Most brokers charge you a transaction fee to invest in individual stocks. There are some platforms out there now such as RobinHood that allow you to invest commission free.
However, in Robinhood's case you cannot automatically reinvest the dividend so you will manually have to reinvest it. If you're dealing with small amounts of money, you won't be able to reinvest that money because you can't buy fractional shares outside of an automatic dividend reinvestment plan.
No worries, though. Just keep saving those dividends and when you have collected enough you can use those proceeds to buy more. It won't be long and you will be collecting enough dividends to reinvest in the stock every time.
Lets take you through a few examples of three families investing in dividend paying equities and reinvesting those dividends over time:
Average American Household Income
According to the U.S. Census Bureau via USA Today, the average American household income was $73,298 in 2014, which is the latest year for which complete data is available. I could make a million assumptions in this example, but that would defeat the purpose so I'm just going to keep this simple.
Let's suppose this family used the general rule of thumb of saving 20% of their income and they were able to do this over a long period of time and they chose to invest in a good dividend paying mutual fund with a long track record. For this example, I'm using the dividend calculator over at Investopedia.com.
Let's say when they got started they saved for a year before they started investing. So, 20% times $73,298 is $14,660. Starting when they were 25 they invested $14,660 and decided to start contributing monthly (at the 20% savings rate) which amounts to $1,221 per month. Inputting this information into the calculator assuming a dividend growth rate of 3%, dividend yield of 4%, dividend reinvestment period of 30 years, and an assumed growth rate in share price of 4.8% the value of the account at age 55 is $1,589,079.89! On top of that, they would have earned over $150,000 in dividends alone that year without touching the principal! Fast forward to their sixties and they are quickly approaching over $200,000 in annual dividends. Talk about passive income.
Now before you nerds out there give me a bunch of crap, yes this is simplistic. I made a lot of assumptions and the above calculations don't adjust for inflation. But my point is bigger than that. If you are going to let the above example ruffle your feathers because I didn't include inflation and you decide not to invest then that is your loss. Even with inflation factored in, the numbers get big and your quality of life improves. That alone is enough to START.
Slightly Above Average Household Income
Let's use all of the same assumptions above, except this time we are going to assume the household earns $100,000 per year. At a 20% savings rate the results are dramatically different. Their initial investment of $20,000 and $1,666 each month afterwards for 30 years turns into $2,168,209.33 and over $210,000 in annual dividend income at age 55.
Above Average Household Income
This ones just for fun. Assume household income of $200,000 per year and all of the above assumptions. The numbers grow to $4,337,64.87 and $421,143.72 of annual dividend income at age 55. That's just awesome! Also, you have to remember I'm using conservative numbers here. The average annual return over 30 years is actually higher than the return assumptions I used above and I only used a 20% savings rate. I know many individuals, including myself, with savings rates approaching 50% and much higher!
Now I know a lot of you out there are probably thinking "You can earn a lot higher returns." That is very true, and trust me I earn higher returns with my investments.
But, if that is what you are thinking then you are missing the point. What is your freedom number? I choose a 4% dividend return because I want to get to a point where I can comfortably live on that return.
If I can live on a 4% return, then it doesn't matter what the price of the stock does year to year. That's true financial freedom and that freedom will allow you to chase what you're truly passionate about.
If you're interested in learning more about dividend investing, I suggest you start here:
Introduction to Dividends: Investing in Dividend Stocks - https://www.investopedia.com/university/introduction-to-dividends/investing-in-dividend-stocks.asp
Here's a good YouTube video that discusses dividend investing. https://www.youtube.com/watch?v=KfbK1QBTAlI&t=155s
Want to play with a good Dividend Investment Calculator? Check out this one! https://www.investopedia.com/calculator/dvcal.aspx
Thanks for reading!