Dividend growth investing is a common sense approach to wealth building and used by millions of people to build retirement security. While dividend growth investing requires a time horizon of 10 or more years, it is fairly simple to learn and apply.
The foundation of this investment style is to invest in sound, well-managed companies with long track records of paying and increasing dividends. The secret to success is that rising dividends over time grow your money through the compounding of reinvestment.
Compounding dividend growth is a great wealth building system as it exponentially super-charges the rate that your money grows. The great investor, Warren Buffett, will not buy non-dividend paying stocks. He fully recognizes the increased wealth that dividends provide.
During its 94 year history, over 50% of the S&P 500 total return came from dividends. The average annual return since inception is around 10% with dividends reinvested.
For example, assuming a current annual dividend paid of $3.00 per share at annual growth rate of 7% and the stock price growing at 5%, $10,000 invested would increase to $57,108 over 20 years. The reinvested dividends alone would be $21,823.
Out of all American large-cap to mega-cap stocks, 513 pay dividends. Many are considered blue chip companies that meet or exceed the growth rates just mentioned.
Here are three examples of companies that exceed these growth rates and the years they’ve increased dividends: Johnson & Johnson – 54 years; Procter Gamble – 58 years; 3M – 60 years.
Dividends are also indicators of well-managed companies with sound business models. Dividends are real money whose source is a strong balance sheet, good cash flow, and low corporate debt.
Foundational to this method is investing in companies that continue to grow under varied economic conditions. Dividend growth investing is a tortoise vs hare approach to wealth building and requires companies that have long histories of success in all economies, both good and bad.
Dividends provide peace of mind during market downturns. The stock market historically goes through periods of highs and lows, with sharp fluctuations in share prices.
Down markets provide opportunities to buy company shares at bargain basement prices, and the growing dividends pay the investor to wait for market turnarounds. Stock shares bought at discount with dividends reinvested help smooth the long-term ride in the market. This provides a margin of safety.
The dividend payment is not tied to stock share price. Investors receive cash dividends from well-run companies that are in good financial shape. This, too, gives a margin of safety.
Reinvested dividends also build a hedge against inflation. Even a 3% rate of inflation will stymie the real purchasing power of a dollar bill, reducing it to about $0.55 cents over time.
$10,000 hit with 3% inflation over 20 years is reduced to $5,536.76 spending power. An investor would need $18,061 to have the same buying power as the original $10,000.
On a nest egg of $100,000 in retirement funds, the lost purchasing power would equal $55,367.58. It would take an amount totaling $180,611.12 to provide the same security.
To summarize, you cannot match inflation and expect to build wealth. You must exceed inflation by a significant margin to give yourself a good retirement cushion.
Over the long-term, dividend-paying companies provide average annual returns of 8.5% vs the 4.3% return of non-dividend stocks. Still, yet, companies with growing dividends return 10.6%.
The power of compounding dollars through dividend reinvestment is one of the greatest wealth builders available to everyone, and dividend growth investing puts this power in your hands.