If I had to make a short list of my favorite things about following a dividend growth investing strategy, one of the spots would be devoted to the fact that even if you hit a tight spot in your life and cannot continue to invest, the companies that you have acquired continue to chug out profits and dividends. In other words, your dividend tree continues to grow even if you stop watering it with fresh cash contributions.
I’ll give an example. Let’s say you find yourself in a situation like this: You have $5,500 to invest in a Roth IRA account this year, but next year, you expect money to be tighter (maybe you are getting a new roof, sending kids to college, etc.) and won’t be able to make any investments. Some people may think that if you have to take investing “pauses” at some point in your life, you are somehow messing up. That is not the case at all. While the continual addition of capital can help the compounding process along nicely, the fact that you stop making new additions still means that the money already invested continues to compound. That is the fun thing about the snowball nature of compounding: even if you stop adding to the size of the snowball on your own, it still continues to get bigger even if you do nothing.
Let’s imagine that, say, you want a high current yield and reach the conclusion that buying the B shares of Royal Dutch Shell is one of the few ways you can get present income without “reaching for yield.” A full Roth IRA contribution of $5,500 into the oil giant would give you about 82 shares at current prices. Right off the bat, you are generating $73.80 every three months ($295.20 every year) even if you cease to add anymore. Assuming we still use oil and natural gas for time to income, that income continues to compound silently in the background even if “real life” happens and you do not make any future contributions in 2014.
If you choose to reinvest the dividends, you might net 4.5 new shares of Shell over the next twelve months simply by checking the “reinvest dividends” box in your brokerage account. If the company raises its dividend in 2014, as it has the historical tendency to do over time, your results should amplify even further. If shareholders get a 6.67% dividend hike, those Shell shares should be paying out $0.96 per share every three months. Look at what happened over the course of twelve months while you did absolutely nothing but provide the initial capital. Those 82 shares that were generating $295 each year turned into 86.5 shares churning out $332 per year. While other people are getting caught up in the daily stock prices and worrying about what Jim Cramer has to say next on CNBC, you got to see your income go up 12.5% in just one year due to reinvesting your dividends and receiving a dividend increase.
Without any further effort on your part, that $5,500 investment that you made in Shell Oil this year could likely pay you about $1 per day sometime in the next eighteen months due to the power of reinvested dividends and dividend growth alone. If your goal is to generate $40,000 in annual passive income, that means you need a little bit over $109 per day to live. A $5,500 investment in Royal Dutch Shell today could meet almost 1% of your retirement needs within a year or two.
And that doesn’t even touch upon what happens if you diligently reinvest your dividends over a 10+ year time frame and reap the full compounding effects of dividend reinvestment intermingled with dividend growth. The fun thing is that each individual blue-chip investment is a dividend tree in its own right. Just by clicking the “reinvest dividends button” and allowing an excellent business the opportunity to do its thing and raise its dividend each year puts your investment on an autopilot path to increase your income every three months that your dividend gets reinvested. The regular increases are just icing on the cake. This is what makes the whole thing fun. Even if you cannot contribute as much in the future as you’d like, the dividend tree that you plant today is something that can grow in its own right.
Originally posted 2013-06-07 09:00:09.