My Dividend Growth Portfolio is a demonstration of the power of dividend growth stocks. You can take a look at it anytime by using the pull-down menu above.
An important part of my dividend growth strategy is to reinvest dividends. Reinvesting leads to compounding. Compounding is one of the most powerful financial forces in existence. Compounding means to make money on money already made.
You already made the dividends. The companies sent them to you. When you reinvest them, you set yourself up to make money on money already made.
Once compounding is set in motion, it produces extraordinary results. Take a look at this graph.
What this shows is the income from two investments, one with a compounding dividend (the blue line) and the other with a static dividend (orange line). Both dividends start at 4.8% current yield.
The first investment grows its dividend at 6% per year, which is reinvested, leading to the compounding.
The second investment does not grow the dividend, nor is it reinvested.
It just pays the same amount each year.
You can see the compounding effects for yourself.
Isn’t that amazing? The blue line just takes off from the orange line.
By year 10, annual income is nearly triple the non-compounding dividend. By year 20, it is more than 8 times as much.
By the way, here is how I generated that graph. The website is called Miller-Howard Investments, and the graphic generator is called “Income Yield on Original Investment Calculator.”
I input the following values on the control panel:
So the first investment (blue) has a 4.8% dividend, 6% dividend growth rate, and I checked the box to reinvest the dividends. The second investment (orange) has the same 4.8% yield but no dividend growth or reinvestment.
I urge you to play around with that calculator. Invent different scenarios and see how they play out. When you use the calculator “live,” you can hover your cursor over each data point and a little box will pop up to show you exact values.
OK, this article is about my own dividend reinvestment. As you may know, I do not “drip” dividends in my Dividend Growth Portfolio. That is, I don’t reinvest them automatically into the stocks that sent them to me. Instead, I let them pile up in cash, and I reinvest the cash into a single selected stock when the cash pile hits $1000.
That happened on August 20. I do not sit on dividends when they hit the trigger amount. I pre-identify investment opportunities that will improve my portfolio. As soon as my incoming dividends hit $1000, I pick one of the top candidates from my “shopping list” and buy it.
What I decided to do this time is to purchase more shares of a stock I already own: Phillip Morris International (PM). PM’s current yield is 4.8%, so that is why I selected 4.8% yield for the graph above. My estimate for PM’s future dividend growth rate is 6% per year, and that is why I plugged 6% in for the dividend growth rate.
How will Phillip Morris improve my portfolio? By creating more income. I update the portfolio display at the end of each month. Last time (at the end of July), my PM position looked like this:
PM’s current dividend rate is $1.00 per quarter per share. That means that, before the new purchase, PM was delivering $1 x 37 x 4 = $148 per year to me.
The $1000 reinvestment bought me 12 shares of PM. Those 12 shares will deliver $1 x 12 x 4 = $48 more to me, for a new total of $196 per year from that single stock.
When I update my portfolio at the end of the month, PM will show 49 shares owned, and its position will jump to about 5.2% of the portfolio.
Let’s think about dividends some more. The total portfolio delivery rate for dividends prior to this purchase was about $3,329 per year. By adding the $48 more income that I just bought, I increased the whole portfolio’s annual income by about 1%.
Maybe that does not sound like much. But it is a building block in the entire structure. In 2015, I will make 4 dividend reinvestments. (The purchase of PM was the third reinvestment this year.) On average, those reinvestments combined will increase my total income by about 4% over the course of the year.
That, my friends, is the very definition of compounding: I am making more money than before, as the result of money already made.
Let’s take it a step further. The added income resulting from dividend reinvestments is just part of the story. The companies themselves raise their dividends each year. In PM’s case, they last raised their dividend by 6.4% in September, 2014. They increase annually, so I am expecting them to increase their dividend in just about a month.
Here is what their last 4 dividend increases have looked like.
The blue line at the right edge of the graph will jump up as soon as they announce their next increase.
We don’t know exactly what they will do until they do it, but let’s say that they increase their dividend 6%. That means that all of the numbers above – the payout rate, the amount of income that I get from PM, and the like – will go up by 6%.
For example, the new total of $196 per year from PM alone? That will go up to about $208. What will I need to do to get that? Nothing. That’s how dividend growth investing works.
— Dave Van Knapp
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DGI Lesson 4: The Power of Compounding
DGI Lesson 5: The Power of Reinvesting Dividends
DGI Lesson 10 (Part 1): Reinvest Dividends Selectively to Enhance Your Returns
This Portfolio Generates Dividend Income that Rises 15% per Year