The Compounding Power of Dividends

Since I began my dividend growth investing journey at the age of 20 in September 2017, it has really set in how blessed I am to have discovered DGI in my early teens. I always knew how powerful dividend growth can be with the hypothetical scenarios of "x dollars invested in x company 30 years ago would now be producing y in dividends." Well, now that I've began investing in dividend paying stocks and that I am at $495 in annual forward dividends as of January 18, 2019, I thought it would be interesting to examine the compounding effects of these dividends in the coming decades. Interestingly, this whole discussion randomly came about in conversation with my mother one day and she thought that my situation was pretty impressive for someone my age (credit to my mother for this post).

                                              Image Source: Pexels

For illustrative purposes, I'll be factoring in what I believe to be realistic assumptions for our model. I will use the following variables:

• 4% dividend yield
• 6% long-term annual dividend growth rate (DGR)
• Reinvestment of dividends
• No fresh capital contributions
• Average of 5% annual stock price appreciation (almost in line with my long-term DGR)
• 4% average annual inflation rate
• Assuming starting annual dividends of $500 (roughly where I am at the time of writing)

The 4% dividend yield is considerably below my current dividend yield of 4.64%, including my retirement account mutual fund holding. Over time, I'll lower my average dividend yield to around 4% to attain more dividend growth (allowing me to better combat inflation and maintain purchasing power).

As shown below, my current 5 year annual dividend growth rate stands at 6.1%. This is right in line with our projections. We do have to take into account that the past 5 years of economic conditions have been favorable for companies, but with that said, I do believe that as I prioritize dividend growth in the future, the portfolio should be able to at least maintain the current dividend growth rate for the long term.

We'll be factoring in an average annual inflation rate of 4% as it's a bit above the historical average. We'll also assume that I continue to reinvest dividends selectively along the way into companies with attractive starting yields and growth profiles, with no additional capital contributions. This allows us to best illustrate the power of compounding. 

Image Source: Simply Safe Dividends screenshot

Having laid out the assumptions of 4% dividend yield and a 6% annual dividend growth rate above, we'll now examine the impact of dividend reinvestment in terms of nominal dollars and inflation adjusted dollars over the following time frames:

• 5 years: $738.30 nominal annual dividends ($606.83 in 2019 dollars)
• 10 years: $1,212.01 nominal annual dividends ($818.79 in 2019 dollars)
• 20 years: $3,365.94 nominal annual dividends ($1,536.17 in 2019 dollars)
• 30 years: $9,761.96 nominal annual dividends ($3,009.80 in 2019 dollars)
• 40 years: $29,692.56 nominal annual dividends ($6,184.64 in 2019 dollars)

As a side note, I referred to the fantastic dividend investment calculator over at Investopedia to arrive at these calculations. If you haven't checked it out, I highly encourage you do so. I've found it to be a great illustrative tool when you're curious what your dividends could become. You can even incorporate regular capital contributions into the assumptions as well.

Conclusion:

The results above really speak for themselves. We can see that even a bit of planning in your teens or twenties can pay massive dividends (pun intended). If one would simply max an IRA or Roth IRA upon college graduation for 2 years, they could put themselves in my same position. By the time they would reach the traditional retirement age of their early to mid 60s, they would be collecting over $6,000 a year in dividends in today's dollars if they never contributed another dime. In other words, if they completely failed in life and were never able to contribute another dime to their investment account, they would still receive over $6,000 a year in dividends from their retirement account (that also likely wouldn't be able to be touched by creditors due to the protection of retirement accounts in general). 

One can only imagine the impact of fresh capital contributions on top of this capital base for several years or even decades. When one amasses even $500 a year in dividends in their early 20s, they at a minimum set themselves up for $6,000+ a year in inflation adjusted dividends. When combined with regular capital contributions and a high savings rate, it becomes very possible for dividends to unlock financial independence at an early age in life. If you don't believe me, just take Jason Fieber's word for it. He's living his dream life in Thailand entirely because of years of diligent saving and dividend growth investing.

Discussion:

Have you ever used the dividend investment calculator at Investopedia? Have you ever projected dividends 5 years, 10 years, or even 20+ years into the future? What are you thoughts on the compounding magic of dividends? As always, thanks for reading and I look forward to reading and responding to your comments.