You’ll hear me talk a lot about the returns of an investment in a steady, reliable dividend stock. I will generally use two baseline numbers. The first is an overall stock market rate, for which I use 7% annual returns. Some people will tell you it’s higher than this, but I like using 7% to account for inflation. After all, it’s always better to be pleasantly surprised by a larger return than pissed off at a lesser return. The other stat I commonly use is 3.5% for dividend payment return, simply because it’s a nice average among most safe dividend paying stocks. The 3.5% is NOT inclusive of growth you will get in the price of the stock, so you can anticipate approximately 3.5% extra return within the price. Given the way the stock market works, you’ll almost never get an exact 7% overall return. It will come in forms of positive years way over 7% and negative years way under 7%. Nonetheless, it’s been pretty consistent since the early 1900s. One of the best parts of being a dividend investor is that we can easily estimate a portion of our overall return by what companies are paying through dividends. Therefore, we take out a portion of market volatility by not relying strictly on stock price increases.
I know that these examples of past performance will never replicate exactly for us in the future, but given that I’m not one of those ridiculous palm reader/fortune teller people that pray on people at the beach, I can’t predict what will happen in the future with our stocks. Looking at past success is the best way to give you an idea of what your invested dollar will be worth. This is meant to show that patience allows our stocks to grow into sizable chunks, and provides us with an ever-growing income stream when we invest enough of those chunks. Also, it will show the power of re-investing our dividend payments by buying more shares over the course of our investment.
Let’s take a look at a hypothetical example using Procter & Gamble stock. If you don’t already know, the company has many different consumer brands within its portfolio, including Tide, Downey, Vicks, Duracell, Crest, Febreeze, and Olay (just to name a few). This company is one that I will always be comfortable buying and a stock with a long history of dividend payments. Therefore, we know that I would have recommended this stock in 2010, as well as today. PG currently pays a 3.44% dividend and has maintained/increased that dividend for 58 straight years through thick and thin.
Scenario 1: Buy 16 shares of PG @ $60 per share for a total investment of $960 in January 2010 (using dividend/price data from 2010 to 2015)
Let’s say we traveled back in 2010, when we were just young bucks, and decided to make a kickass decision to invest in PG stock. Right off the bat, we know we are receiving 2.88% return in cold hard cash through their dividend payments. That percentage comes with over 50+ years of consecutive, increasing payments. So we know our investment is paying us $2.35 per month forever ($7.05 quarterly payment). The beauty of building a portfolio is we do so dollars at a time and can actively see it building. My guess is we won’t miss the month of eating out or spending money at bars after the given month is over, but we enjoy the returns immediately and forever. If you look at the $2.35 and are unimpressed, understand that it’s a FREE $2.35 per month forever, for your one time investment. You don’t have to do anything to work for it. It will always be there as long as the company exists. So we restrict spending for a given finite time period, and get a return (albeit a small return at first) for an infinite time period. Seems like a damn good trade off to me. But the $2.35 a month is just the start of our investment journey.
So that’s just the initial dividend payoff for our $960 investment. Let’s look at total return for our investment over 5 years:
In October of 2015 (today) we look at how our investment is doing:
We’ve received dividends every quarter of every year for a total of $219, and in this scenario we chose to spend that money along the way.
The stock price now sits at $77/share, or a $17 per share improvement. Price growth = $17x16 = $272 (~5.7% annual)
Dividend Payment has increased to $3.54 per month from the initial $2.35. Dividend growth = 51.0% increase (~10.2% annual)
Overall market value of our return is $219 dividend payments + $272 price growth + $960 initial investment = $1,451. Total return = 51% over 5 years (~10.2% annual)
Keep in mind - this is without ever investing another freaking dollar after the one-time $960.
Scenario 2: Same initial investment, but re-investing dividends received
We’ve received dividends every quarter of every year for a total of $236, choose to buy 3 more shares over the course of 5 years, and we end up with 19 shares in 2015.
The stock price now sits at $77/share, or a $17 per share improvement. Price growth = $17x19 = $323 (~6.7% annual) - 18.75% annual lift with re-investment
Due to owning 3 extra shares our monthly dividend payment has increased to $4.20 from the initial $2.35. Dividend income growth = 78.7% increase (~15.74% annual) - 18.6% annual lift with re-investment
Overall market value of our return is $236 dividend payments + $323 price growth + $960 initial investment = $1,519. Total return = 58.2% over 5 years (~11.6% annual) - 13.7% annual lift with re-investment
Pretty significant difference with re-investing our dividends on display here. And consider that over the course of our working lives we will be saving A LOT of $960 chunks, so these differences add up to be a very substantial difference. Since 5 years is a relatively short time period of our overall salary generating years, we will continue to see more and more of the compounding effect going forward in both the price growth and the dividend income growth.
For those people saying "Woah, he's using way too many fucking numbers"...hopefully I haven't lost you yet, because I've got you covered. Here is a graph of the dividend investing piece of the puzzle. The green line represents if you were to reinvest your dividends and the blue line represents if you didn't. The y axis is potential quarterly dividend payments (divide by 3 for monthly). As you can see as more and more time goes by the gap widens. Using re-investment is a VERY powerful way of jump starting your portfolio. Keep in mind that re-investing helps your return within the price growth as well (not pictured here).
These scenarios should give you an idea of how powerful dividend growth can be. The same numbers can be calculated for any investment amount. Some of us can only afford to invest $50 a month. The same percentages hold true. Sure, the numbers will start out small, but getting in an investing habit will surely bring long term wealth. The above example is just one investment, so you can imagine how it works with regular investing. If you are lucky enough to invest $960 5-6 times per year, than you have similar price growth working concurrently for those 5-6 investments. You can see how this stuff really snowballs once you get going.
It’s not all rainbows and butterflies all the time in the market, so let’s cover the other possibility. As I’ve stated in other posts, the stock market return is NOT guaranteed to be smooth sailing over the course of a small period of time, in fact it probably won’t be. In this example, the stock went up for the most part, hitting its peak in 2014 at about $90, and then dropped down to the $77 today that we used in our example. It’s very possible you buy the 16 shares of stock and the stock market goes DOWN for the next year or two instead of increase like in our example.
Three points regarding that scenario:
We don’t sell our stock in recessions. That’d be equivalent to buying a $1000 TV and selling it the next day to someone for $750. Remember, we only invest money in the stock market that we won’t need in the near future. Therefore, we can afford temporary losses in value.
We know that our dividends are safe in recessions with stocks like PG, given that they have maintained/increased dividends for 58 straight years.
If you play it cool when everyone else panics and are re-investing your dividends and/or making new steady investments (highly recommended) during the stock dip, you’ll know that you are now getting new shares at a nice, discounted rate.
As I said before, we can’t know what will happen in the stock market in the future. In fact, we pretty much can be assured that recessions will happen.
The things we DO know in the stock market:
Dividend companies with a long history of performance are more predictable and reliable than the stock market itself over the short term. Companies like PG, Coca Cola, WalMart, and Target have proven to be able to sustain multiple recessions by continuing to pay dividends even when their respective stock prices are falling.
The stock market has always gone up at an average rate of 7% annual since the early 1900s (although often it won’t be up over short term periods such as 1,2 or even 3 year periods).
So next time you do something to positively cut down your budget and make an investment with the money saved, know that it is positively affecting your net worth if you give it time to grow in the market. Sure, you’ll start out only getting an extra $5 bill in your pocket every month, which might not seem significant, but if you stay the course pretty soon the stock market will basically be shooting a shitload of $5 bills at you regularly through one of those fun t-shirt guns. And that’s the fucking dream, isn’t it?