What is every employee’s worst fear? While I cannot answer that question with absolute certainty, I’d be willing to wager that a forced early retirement (be it due to layoffs or a forced termination due to poor performance) is on the short list of things that an individual likely fears. One of the appeals of income investing is that it is a measurable defense mechanism against job insecurity.
Let’s say that your annual salary is $50,000 and you manage to save $5,000 each year, or 10% of your pre-tax pay. At the time I am writing this, GlaxoSmithKline, BP, Royal Dutch Shell, and AT&T currently offer investors entry yields of 5%. That will give you $250 in annual income. With that single $5,000 investment, you have just replaced 0.5% of your total salary.
That may not sound all that impressive at first, but the key is to realize what you have just done: you have acquired an immensely profitable business that chugs out more and more profits over almost all five year rolling periods, speaking historically. Those profits have a tendency to grow over time. And if you reinvest your dividends along the way, you can amplify the growth of your annual income substantially.
But most people don’t pay attention to those “puny dividends” and the income kick you can achieve by reinvesting your dividends. Ten years ago, AT&T traded at $27 per share. Today, it trades at $36 per share. That is only a 33% increase in capital. Considering you delayed gratification for ten years of your life, that may not seem like the greatest reward in the world.
But when you start adding up the dividends paid out, and the reinvestment of them, the totals start to look a little bit better. A $5,000 investment into AT&T ten years ago would have netted you 185 shares. At the time, AT&T paid out $1.37 in dividends that year. You would be looking at $253 in annual income right off the bat.
But nowadays, AT&T pays out $0.45 per share in dividends, or $1.80 in total. That means you’d be getting $333 in annual income, right? Well, yes, if you spent your dividends along the way. But if you checked the “reinvest dividends” on your brokerage account for the past ten years, the results would have been even better. Your 185 shares would have grown into 314 shares (this is the kind of fun stuff that can happen when you reinvest $141 automatically into a share of stock that trades at $36 per share and pays out $1.80 per share of its own in dividends). In total, you would have 314 shares churning out $565 in total annual income. Over ten years, your income would have grown from $253 to $565, for an increase of 217%.
That is why the reinvestment of dividends is the secret to everything. At first glance, AT&T didn’t appear to do anything remarkable over the past decade. The dividend only increased from $1.37 to $1.80 per share. The share price only increased from $27 to $36. It doesn’t look like anything all that phenomenal is going yet. Yet, you were able to double your income just by coming up with $5,000 in initial seed capital and checking the reinvest dividends box on your brokerage account. It required no additional effort from you. No continued expenditures. All you had to do was come up with the initial $5,000 in capital, and the rest of the wealth building process occurred on autopilot from there.
In ten short years, that $5,000 investment in AT&T came to generate $565 in annual income, replacing 1.13% of your annual salary. A single $5,000 decision, given a decade’s worth of time, got you 1% of the way towards your goals. And here is where things start to get fun: the reinvestment of dividends is like a snowball. Each higher dividend reinvested goes a greater distance when it comes to getting you closer to your goals. That $565 in annual income will pick you up about 16 shares over the course of the next year, which themselves will be able to generate at least $29 in income all of their own (and that is without factoring in AT&T’s dividend increase, which will march you even closer to your goals).
That is the key to combating the “forced retirement” nightmare that plagues some investors. It’s all about making one $5,000 investment after another, and watching the income grow. In just ten years, AT&T came to represent 1% of your necessary income. If the income doubles again over the next ten years to $1,130 in dividends, it will represent over 2% of your retirement needs. That’s the symphony you need to get started in your own life. It’s all about making one $5,000 investment after another. Get the income churning. Calculate how much money your passive holdings are paying you each day for just staying alive.
Right now, that $5,000 investment in AT&T will pay you $1.54 just for staying alive. Combined it with another $5,000 investment you made in a cash cow nine or eleven years ago, and you’d be able to raise some hell at the McDonald’s dollar menu on any day of your choosing. And it would all be passively generated.
As investors, we have three tools that determine our future: the amount of capital we set aside, the amount of time we can set it aside for, and the growth rate we can get over that time. Plant those friggin $5,000 trees. Reinvest the dividends. Plant another $5,000 tree. Watch it grow. And then do it again. That’s the key to security. The more time you give it, the better off you will be. If you want a backup plan to your current job, you need to start planning now. You need as much time to let the income grow as you can give it. You need as much time to plant those $5,000 dividend trees as you can. If you want to take actions today that will provide a safety blanket to your future self, those are the kinds of steps you gotta take.
Originally posted 2013-07-18 07:38:15.