I follow a dividend-growth investing strategy. I invest for the long term in the stocks of companies that not only pay dividends, but consistently increase their dividends from year to year. I reinvest the dividends and invest new funds I save from my job income. My goal is to create a sustainable, rising stream of dividend income that will eventually exceed the income from my job and allow me to be financially secure in retirement. I am working to achieve this goal by building and maintaining a compounding machine that has three key parts: dividend growth
, dividend reinvestment
, and investment of new funds
To illustrate the power of this strategy, below is a figure that shows the change in projected annual dividend income over a 30-year period under different conditions. Unless otherwise specified, the projections assume initial investment of $40000, initial dividend yield of 3.25%, annual dividend-growth rate of 7.2% (the rate at which dividends would double every 10 years), annual capital-appreciation rate of 5.0%, dividend-tax rate of 15% (with all dividends taxed), annual investment of $12000 in new funds ($1000 per month), and all investments occurring at the end of each year.
The conditions shown in the figure are as follows:
- Baseline: No dividend growth, no dividend reinvestment, and no investment of new funds. Dividend income stays flat at $1300 per year.
- DR Only: Dividend reinvestment only; no dividend growth and no investment of new funds. Dividend income is $1968 at Year 30.
- DG Only: Dividend growth only; no dividend reinvestment and no investment of new funds. Dividend income is $9763 at Year 30.
- NF Only: Investment of new funds only; no dividend growth and no dividend reinvestment. Dividend income is $7205 at Year 30.
These results suggest that each part of the compounding machine has a relatively weak effect in isolation. However, consider what happens when you put two of the parts together:
- DR + NF: Dividend reinvestment and investment of new funds; no dividend growth. Dividend income is $9226 at Year 30.
- DR + DG: Dividend reinvestment and dividend growth; no investment of new funds. Dividend income is $26989 at Year 30.
- DG + NF: Dividend growth and investment of new funds; no dividend reinvestment. Dividend income is $54111 at Year 30.
These results suggest that dividend growth in particular has a strong effect when combined with either dividend reinvestment or investment of new funds. However, consider what happens when you put all three parts together:
- DR + DG + NF: Dividend reinvestment, dividend growth, and investment of new funds. Dividend income is $115444 at Year 30.
This final result shows the full power of the compounding machine that is at the core of my dividend-growth investing strategy. I consider the assumptions underlying the calculations to be fairly conservative, which is why I aspire to do better than what is shown. That's right -- I think it is realistically possible to achieve annual dividend income well in excess of $100000 after 30 years by following the basic principles of dividend-growth investing. It is a sensible investment strategy that takes advantage of the powerful effect of compounding over time, which is why I like to say that dividend-growth investing makes a lot of sense and a lot of cents.
Hi Deedubs, Thanks for sharing and outlining the information. Sure I agree with the Strategy, however can we really expect annual capital-appreciation rate of 5.0% year over year. Please share your thoughtsReplyDelete
It turns out that the outcome gets better as the capital appreciation rate gets lower because dividends can be reinvested (and new funds invested) at lower cost. Consequently, the strategy works best in a flat or bear market compared with a bull market, so I would be fine with a capital appreciation rate below 5%.
Hi Deedubs, Thank you for your response. Yes, i could not agree more on the flat or bear market. It does bring down our cost basis. My thought is that, if we get less than 5% returns on capital appreciation, can we make it to the goal of 110K in dividends after 30 years. In other words, say we only get 2% to 3% of cap appreciation and DG can we reach our goal?Delete
Under the conditions specified above, here is how long it would take to reach $100,000 in annual dividend income for different capital appreciation rates:
5%: 29 years
4%: 27.5 years
3%: 26 years
2%: 24.5 years
1%: 23.5 years
0%: 22.5 years
Thus, a low capital appreciation rate makes it easier to reach a dividend income goal. However, these projections assume a fixed rate (e.g., 5% every year), which is highly improbable. I have not explored what would happen in different scenarios that allow for fluctuation in the rate around an average. Of course, the projections also depend on whether the other assumptions (e.g., dividend growth rate of 7.2%; savings of $1,000 per month) can be maintained over 30 years through satisfactory portfolio management and expense controls.
Hi, this is THE best illustration of the compounding effect of dividend investing I have ever seen...awesome graphs, and very eye-opening. Hope you dont mind if I link to this?ReplyDelete
Hi High Yield Soldier,Delete
Thanks, I appreciate the feedback! You can feel free to link to this page. Also, if you have not read it yet, I have an article at Seeking Alpha that shows the individual effects of various factors on long-term compounding of the dividend income stream:
Thanks for your work on this blog and the great articles at SA.
I understand that your strategy will create a portfolio where dividend growth rate will handily outpace inflation, but I'm struggling to interpret that with the results you've outlined here.
Should your final outcome of 115,444 be discounted by a factor of 2.43 (1.03^30) to account for inflation?
Also, would you be willing to share your background calculations or is that proprietary :) I've attempted to create my own spreadsheet but as the equations become more complex I lose my way somewhere and wind up with a useless result. Would love to have template to work with.
Appreciate all your efforts and for sharing with everyone. Turning 26 this year and can't wait for the final student loan payment in a few months so I can jump into DGI!
Chris: Thanks for your comment. You make a good observation about inflation: The results shown in the figure are not adjusted for inflation, so the purchasing power of the final dividend amounts would be lower than their nominal values. However, I find it easier to think about the unadjusted dollar amounts.Delete
Regarding the calculations, I recently learned how to use Google Docs spreadsheets for the first time, so at some point I will see whether I can set up an online version of my spreadsheet, ideally where users can modify the starting parameters and see the corresponding changes in dividend income over time. Alternatively, it would be cool to create some sort of app, but my programming skills are too limited to make that a reality.
Thanks for sharing your thoughts on strategy in this way -- it certainly illustrates the benefits of dividend growth investing. I've been reading your blog for several months now and I've learned a lot! In fact, your blog (and several similar blogs) inspired me to create my own dividend growth portfolio and blog (DivGro). I'm still an infant in all of this, so thanks for your continued "teaching".
FerdiS: Thanks for your kind words -- I'm glad that my blog has been helpful with your investing! I will check out your blog -- it is always nice to read about the thoughts and experiences of other dividend growth investors.Delete
Nice illustration of DGI.ReplyDelete
If you factor in average inflation and taxation (on divis and cap equity) the curves get a hell lot smoother and less exponential.
What are your thoughts on that?
Anonymous: Thanks for your comment. The curves already assume that all dividends are taxed at 15%. If taxes can be reduced (e.g., by holding some stocks in a Roth IRA), then the detrimental effect is weakened.Delete
The curves are not adjusted for inflation. If one assumed a long-term inflation rate of 2.4%, then $100,000 in dividends after 30 years would have an inflation-adjusted value of about $50,000, which is still pretty good.
Great article thanks for sharing. I too firmly believe in the dividend growth investment strategy, so much so that I built a website to help youngish investors achieve financial freedom and retire early using this very strategy combined with buying great companies with competitive advantages when they are below fair value (value investing). You and your readers might be interesting the tools that I developed specifically to help Dividend Growth Investors. The site is www.dividendgeek.com signing up is free. Let me know what you think I'm always looking for new ideas to help DGI investors.
Keep up the good work on your site and your goals!
Blaine: Thanks for your comment and for stopping by! I'll be sure to take a look at your site. Best wishes!Delete
Hi Dividend Growth Machine,ReplyDelete
Love the analysis.
There is one "tweak" that I would strongly suggest: The capital growth rate (5.00%) shouldn't be less than the dividend growth rate (7.20%). Over 30 years, this substantially alters the dividend yield.
The reasonable assumptions of 3.25% yield and 5.00% capital appreciation become nearly a 6.00% yield and 5.00% capital appreciation after 30 years:
Assume a stock price of $100 in year 1, with a dividend of $3.25. At year 30, the stock price would be $412 after 29 years of 5.00% capital appreciation. Dividends would be $24.41 after 29 years at 7.20% dividend growth. $24.41/$412 = 5.93% dividend yield.
If you tweak the assumptions to: 3.25% dividend yield, 6.25% capital appreciation, and 6.25% dividend appreciation, the $115,444 becomes $64,398. Those assumptions are a bit rosier (3.25% yield plus 6.25% appreciation) than the initial assumptions (3.25% yield plus 5.00% appreciation) ... but the result is substantially different because investors would be expected to demand a similar yield in 30 years that they demand today.
I know I wrote a lot but, it's a little complex - Just trying to help.
Anonymous: Thanks for your comment. I agree with your suggested tweak; it's better to assume equal rates of dividend growth and capital appreciation. I have made the equal-rate assumption in some of my Seeking Alpha articles and in later blog posts, but I should update these results, too.Delete
Have you come around to publish your formula/calculator via google docs?
I just created my own Calculator using Apple Numbers and as variables I included:
- div growth
- asset appreciation
- avarage holding time of assets
- currency exchange loss (for foreign stocks)
… depending on the assumptions for each of the variables the "income curve" is flatter and less exponential.
I would love to create an online calculator together to share with the DGI community.
Anonymous: I have not done that yet. My use of Google Docs thus far has simply involved copying and pasting data from Excel; I have not tried creating modifiable spreadsheets with calculations. However, it is something I would like to play around with in the future.Delete
Very cool charts! Have you considered writing deep in-the-money puts to increase long-term portfolio returns?ReplyDelete
I explain the strategy at stockstooge.com
SS: Thanks for your comment. I have not taken the time to learn about options yet, but as my portfolio grows larger, it is something I will consider.Delete
How much do you pay for transaction? I see that you do alot of transaction with low number of stock and I am curious?ReplyDelete
Rob: I pay $7 per transaction. I usually aim for a minimum transaction size of $1,400, which keeps my transaction cost to no more than 0.5% of my total cost.Delete
We have the exact same investing style. (div growth, re-invest, new money(savings)). I started in May of 2011. I used the Dividend Aristocrat list then sorted by payout ratio and dividend growth. I might be missing out on some other great dividend stocks, but I sleep pretty well.
Thanks for sharing this analysis. It was really helpful to see the different scenarios. Do you happen to have a spreadsheet that models this out? I'd love to play around with it to determine different outcomes. Thanks.ReplyDelete
If you invested using DRIP & SPP (share purchase plan) then there would be no fees. That would offset the inflation factor to some degree. In Canada we would have to pay taxes on the dividend received, but totally agree that your goal would be achievable.ReplyDelete
It's pretty interesting that this strategy gets better as capital appreciation rates go down. The catch would be finding assets that can maintain a cash payout despite economic turmoil. That said, I know of a few out there but only a limited few.ReplyDelete
The concept seems sound, but the chart seems fictitious.ReplyDelete
Your New Funds alone is supposed to be 12k/yr... however the line for New Funds doesn't even cross the 10k mark after 30 years.... Just the new funds themselves with no gains, dividends ect would be $360k... so why does the chart show it at less than 10k after 30 yrs of 12k/yr investments??
Didn't even bother digging into the other lines...
This is a very interesting web page and I have enjoyed reading many of the articles and posts about dividend stocks, keep up the good work and hope to read some more interesting content in the future. Absolutely this article is incredible. And it is so beautiful.ReplyDelete
Thanks for sharing the blog, seems to be interesting and informative too.ReplyDelete
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