Tucking away high dividend-paying oil stocks in a tax shelter like a Roth IRA is one of the most underrated ways that an investor can accelerate the journey of turning an income stream into an income gusher. Companies like BP, Conoco, and Royal Dutch Shell that give investors a 4-5% starting dividend yield that typically grow over time can be a surprisingly effective way to build up your nest egg.
Let’s take a quick look at what can happen if you use a company like Royal Dutch Shell to augment your nest egg. Right now, Royal Dutch Shell trades at $70 per share and pays out a $0.90 quarterly dividend. On an annualized basis, that means you will receive $3.60. I went to Subway yesterday and I ordered Chicken, Bacon, and Ranch footlong that cost a little over $7. Well, if I owned a mere two shares of Royal Dutch Shell (just $140 worth!), I would be receiving $7.20 in oil money income each year. That teensy tiny ownership stake would allow me to have a “free sandwich” each year.
Let’s look at the kinds of things you could do with a company like Shell if you made it a part of your retirement investing strategy. As of current tax law, you are currently allowed to put $5,500 per year into a Roth IRA (as long as you have at least that much in earned income). At Shell’s current price of $70 per share, that means that you could buy 78 shares of the oil giant to put into a tax-sheltered account that would be free from the reach of Uncle Sam. Right off the bat, you would be receiving $280 in annual oil income. Averaging it out daily, you’d be getting $0.77 just for waking up in the morning.
Now just imagine if you put together a five-year plan that went something like this:
In December 2013, I am going to put aside $5,500 to buy 78 shares of Royal Dutch Shell that I will keep inside of a Roth IRA.
For the next four years, I will automatically reinvest the dividends back into Shell, allowing me to benefit from investing’s “Holy Trinity” when you take cash payments, reinvest them back into the company, and then benefit sometime down the road from dividend growth. At that point, I am going to take the Shell dividends and use them to make brand new investments on other companies. Basically, I’ll be treating Shell like my own little dividend machine that, as long as Shell continues to pump out oil from the ground, should be able to pump money into my tax-deferred retirement account every ninety days.
Here are some quick and dirty back-of-the-envelope calculations of what that might look like:
For putting aside $5,500 into a Roth IRA this December (and another $5,500 in January to act as your 2014 contribution), you would buy $11,000 worth of Shell stock that would give you about 156 shares if you could initiate your position at today’s prices.
As of January 2014, your 156 shares of Shell (say that ten times fast!) would be paying out $561 in annual income.
Assuming you reinvest back into the company at $72 per share, you’d pick up an extra 7.79 shares of Shell.
If the company raised its dividend 6% in 2015 to $3.81 and you reinvested at $75, you’d pick up another 8.32 shares.
If Shell gave you another 6% hike in 2016 (to $4.03 per share) and you reinvested at $79, you’d add 8.77 more shares to your pile of Shell.
And lastly, if Shell raised its dividend by 7% in 2017 to $4.31 and you reinvested at $84 per share, there would be 9.28 more shares coming your way.
Note: These kinds of projections are more art than science. It is impossible to guess the dividend growth rate, reinvestment price, and so on with a very high degree of accuracy, but I tried to build some conservatism into the model by not adding dividend growth in 2014, and I also reinvested annually instead of quarterly, which slows down the compounding process a bit.
Here is what the five-year plan with Shell might look like at the end of your “five-year plan” in 2018: your 156 shares have a realistic shot of turning into 190 shares due to dividend reinvestment. Due to the power of dividend growth, the $3.60 per share payout might grow to $4.61. That means the $561 in 2013 income might grow to $875 in 2018. That’s a 56% increase in just four or five years. That’s not bad considering it required absolutely no energy on your behalf once you came up with the initial $11,000.
If you want to get in the habit of planting the kind of seeds that will give you $1,000 per year to invest in other stocks in a way that will allow you to “wash, rinse, and repeat” the process for the rest of your life, I would suggest you do the following: accumulate $11,000-$12,000 to invest (that means saving $400-$500 per month for two years), invest it into a dividend growth company that both (1) has a starting yield of around 5%, and (2) can give you a dividend growth rate 6-7%. From there, you have to wait about five years or so to get to the point where you get $1,000 per year ($2.73 per day!) just for waking up in the morning. That’s way buying $10,000 or so worth of BP, Conoco, and Shell might be at the top of the list for an income investor.