Investing is not always easy. In fact, with the market being very volatile these days, it can quickly become a very stressful activity.
There is however one way to approach investing that is much more relaxing, the “Wall Street Yoga” if you will, and this discipline is called “Dividend Growth Investing”.
The idea is simple.
Pick stocks that have a comfortable yield (above 2.5%), a long dividend history (above 5 years, preferably 10 years or more), a track record of raising these dividends at least once a year and an ability to sustain that in the future through a low payout ratio (below 50%), a regular ability to generate lots of cash and solid perspectives of EPS growth.
Watch them grow…
The beauty of Dividend Growth Investing is that your patience with your holdings is rewarded: every quarter (for most US stocks), twice or once a year (for most foreign stocks), you will receive cash that you can automatically reinvest through a DRIP (Dividend ReInvestment Plan) if your broker gives you this option. In most good DRIPs, reinvestments are offered without any brokerage fee, which decreases your cost of investing. Letting your DRIP automatically reinvest your money for you is a nice way to put your money to work without overthinking it and loosing your neurons and nerves in trying to time the market…Drops of cash will help your portfolio grow slowly but surely.
The combination of DGI and DRIP has a stabilizing benefit for your portfolio: when your stocks go down, their yields tend to increase which means that your DRIP will buy more stocks for you. That is dollar cost averaging at its best.
If you selected the right holdings, your dividends will not only compound but they will also grow as the companies that you are invested in grow their dividends typically once a year. Big dividend holdings (Like Johnson & Johnson – JNJ and Coca-Cola KO) will typically grow their dividend above 5% per year, which is both above inflation and your typically pay raise. Free Cash Compounding, Dollar Cost Averaging and Dividend growth, this is the magic trifecta of Dividend Growth Investing.
Where do I stand on that? Well, I am glad that I reached a significant milestone in November 2014. For the first time in my portfolio, my dividends rose above $1,000 per year…That is still very far from retirement but it is a nice start.
I still need $49,000 of annual dividends to start thinking about retirement but I also have time. Let me illustrate the power of compounding over time…Many in the investment field call this the “miracle of compounding” also known as the “8th wonder of the world”.
Let’s take my current dividends in Coke. They will bring me $79 of dividends this year. That is probably below my consumption of Coke products in 1 month….Yes, that is one way to look at it….
But what if I kept my holdings in Coke for the next 30 years….Will Coca-Cola (KO) still exist in 2045? Absolutely….Coca-Cola is one of the most solidly established consumer brands in the world and it is not easy to imagine a scenario of strategic disruption or social shift where Coke and its wide range of products would totally lose relevance in the world and simply disappear.
KO has been growing its dividends by 8 to 9% per year over the last decade. What would happen if they kept growing their dividends by 8% over the next three decades?
Well, my yearly modest KO income would grow from $79 to close to $20,000
What if Coke’s performance declines and their dividend growth drops to 6%? I will still get a respectable dividend income of $4,053 in 2045. That is not bad, given my modest original investment (~$2,000). That is a dividend return rate of 30% per year, which is a dream return rate.
A 0% dividend growth over this period would still yield an annual return of 4.46% which is higher that most bonds would offer you today and would give me $175 to buy some Diet Cokes and Honest Teas during my old age….
My experience of Dividend Growth Investing has been very positive so far. I encourage you to build your own Dividend Growth Engine. These things can come in handy to make your life financially more comfortable after you retire. What do you think?