How to Turn Your Portfolio Into an Income-Generating Machine

In 1978, my friend Neil did something unheard of for most people his age…

He started funding a retirement that was still 40 years away.

Every month, Neil mailed off $50 checks to dividend reinvestment plans (“DRIPs”) with household-products behemoth Johnson & Johnson (JNJ), food and drink titans Coca-Cola (KO) and General Mills (GIS), and electric-utility company Duke Energy (DUK).

Over the years, Neil also set up individual retirement accounts, contributed regularly to them, and invested most of his capital into the same four stocks.

(Of course, he bought and sold lots of other positions over the years, but he always felt most comfortable with those four stocks.)

By dollar-cost averaging purchases over four decades and reinvesting the ever-growing dividends, Neil has amassed large positions in four high-quality businesses.

Today, he can stop reinvesting his dividends and start to enjoy the hefty checks… And because he accumulated large positions with rising payouts, he should never have to sell a single share to maintain his lifestyle.

This strategy gets more powerful the earlier you begin.

But if you have some catching up to do, chances are it’s not too late to start compounding your wealth.

Today, I’ll show you how you can take advantage of rare opportunities in the stock market… and turn your portfolio into an income-generating machine…

To better appreciate what Neil has accomplished, let’s look closer at one of his positions…

The first share of JNJ stock he purchased 40 years ago has turned into about 81 shares today, thanks mostly to five stock splits between 1981 and 2001.

JNJ currently pays an annual dividend of $3.60. That translates to a yield of around 2.6%. (For comparison’s sake, the average S&P 500 stock yields 1.9%.)

In other words, Neil’s $85 investment in 1978 will generate $300 in annual dividends today – an incredible 350% yield on his initial investment. (Of course, that’s just dividends alone… Those 81 shares are worth almost $12,000 today, too.)

My friend Neil understood the power of compound interest and will be reaping its benefits for the rest of his life.

“But I don’t have 40 years left to compound my investment capital,” you might be saying…

Fortunately, you’re in luck.

As long as you have 10 to 20 years left to invest, you still have sufficient time to assemble a portfolio earning high yields on your initial stake.

But to make up for lost time, you must get the biggest “bang” for your investment. In other words, to maximize the future income-generating potential of your portfolio, you must buy shares of dividend-paying stocks when they go “on sale.”

The best way to do this is to buy when other investors are panicking. To paraphrase Warren Buffett, one of the great investors of our time, you need to be greedy when others are fearful.

More important, you must take advantage of the biggest mistake investors regularly make: assuming that the future will look a lot like the recent past.

Back in October, I took an in-depth look at this phenomenon here in DailyWealth

I explained that big stock moves almost always occur because investors suddenly change their expectations about future cash flows.

The stock market always looks ahead. The problem is, it doesn’t always get the forecast right.

Markets represent the collective actions of countless humans, none of whom can accurately forecast with any consistency what will happen tomorrow, let alone a year from now.

Consequently, our expectations for the future are often skewed by what has happened most recently.

This is a dangerous bet… one that’s destined to fail.

To borrow a phrase from former Stansberry Research editor in chief Brian Hunt, stock investors like to take the escalator up to the top floor, then jump out of the window to get back down.

As financial results improve from quarter to quarter, investors expect this will continue…

Stock prices move up incrementally in response, as if they’re riding an escalator.

Then, the moment that something happens to threaten the company’s outlook – usually with little warning – investors head for the window all at once.

The same principle applies to the market as a whole.

As you can see in this chart, it took five months for the benchmark S&P 500 Index to ride the escalator up from its 200-day moving average in May to its most recent high… then just six days to give it all back…

But while people are panic-selling at the first sign of trouble, smart investors use the pullbacks to deploy “dry powder” and establish large positions in dividend-paying stocks.

Take software giant Microsoft (MSFT), for instance. The company is one of the most widely owned dividend-paying stocks of the past 20 years.

Think back to early 2008, the last time we experienced such a long, escalator-like bull market run…

Microsoft was trading at a multiyear high near $36 and yielding a paltry 1%.

Then, over the course of 2008, the Great Recession ripped through the U.S. financial markets, sending stock market indexes down more than 50%. Despite operating a largely recession-proof business model, Microsoft wasn’t immune to the sell-off… By early 2009, shares were trading around $16.

Now, almost a decade later, let’s see how buying $5,000 worth of MSFT shares at the top would have fared versus buying near the bottom…

As expected, $5,000 invested at the market bottom sets you up for far greater future income than buying near the top.

Today, Microsoft is once again yielding a measly 1.7%, not much higher than it was back in 2008. If you’re serious about accumulating large positions with the potential for loan shark-like yields, you’ll have to look elsewhere for now.

Recently, my colleague Dan Ferris and I came across one of the best dividend stories we’ve seen in years…

We told our Extreme Value newsletter subscribers all about it in the September issue.

This stock continues to trade near five-year valuation lows, despite management’s upbeat assessment and anticipated 25% dividend increases for each of the next two years. As we detailed in the issue, we think the company could very well raise it 25% for a third time, too. If this situation plays out as expected, shares purchased today could be yielding nearly 9% in three years.

Looking much further out, if dividend growth averages 5% per year over the next two decades, then shares of this company could be yielding more than 20% on capital invested today.

In short, ordinary people like you and me can generate extraordinary wealth in the stock market.

All you need to do is buy high-quality dividend payers… at the right price. Then you can sit back and watch your wealth grow.

Good investing,

Mike Barrett

Source: Daily Wealth