Reinvest Dividends for Greater Long-Term Growth

The following guest post was submitted by Evan, the author of StockInvesting101.net, in response to my post earlier this week about dividend investing.

On Monday Jason wrote a great overview about dividend investing . Since you now know what dividends are all about, I figured it would be a good opportunity to do a guest post on the subject. I write about the stock market and personal finance at my blog Stock investing 101.

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Photo by gfpeck

Dividend investing is the best way to generate passive income and become wealthy, period. It is the perfect example of making your money work for you.

AT&T pays out a 6.7% dividend yield. This means for every 100 dollars of the stock you own you will be given $6.70 a year from the company as a bonus for just being a shareholder of the company. Compare 6.7% to the interest you could get from a standard checking account or a CD. You are getting at least 3 times the return from owning AT&T versus investing in a CD, and that is not factoring in any potential increase in AT&T’s share price.

Most dividend paying companies also offer a DRIP program, DRIP stands for Dividend reinvestment program. If you opt for the DRIP program the money you receive each quarter from owning stock will be used to buy more of the stock instead of being given to you in cash. This is a great way to take advantage of compound interest.

Jason mentioned he purchased 80 shares of AT&T. If he opted for the dividend reinvestment plan those 80 shares would grow to 85.4 shares after just one year. After 5 years his purchase of 80 shares of the company would now have ballooned to almost 110 shares of the company. After those 5 years, assuming AT&T kept its dividend rate steady [which is very conservative when you consider that AT&T has a long track record of consistently raising its dividend] Jason would then be actually getting a 9.3% yield on his original investment. 110 X 1.68= 184.8/ [25.25[share price]X 80= 2020].

The numbers only get more and more impressive and mind boggling over time. In ten years AT&T could go from paying his Netflix membership to making his car payments, in thirty years AT&T could pay his mortgage.

The best thing about this is that there is almost no work involved. After you make your initial investment everything is on autopilot.

Here is a short overview of 5 different dividend paying companies in 3 different sectors to get you started. Remember that this list is not comprehensive in the least bit and it is far from fool proof:

  • AT&T: Jason and I have mentioned this company countless times for a reason. It pays out a whopping 6.7% yield, it is in a stable sector that all of us understand, and I don’t see people getting rid of their cell phones or their Internet connection anytime soon.
  • Coke: Coke is another great dividend paying company. Its yield of 3.2% is not as impressive as AT&T’s but it is still a great value. Coke raises its dividend religiously so I expect even more from it in the future.
  • Pfizer: Pfizer is a huge health care conglomerate. It pays out a very impressive 4.1% dividend yield at the moment and it is a very solid company. It presents a great value to investors.

You will not get 30% yearly returns from investing in dividend paying companies but you will get the best possible return in the long run along with the most stable investment with the least amount of work involved.

If you are interested in learning more about dividend investing, I highly recommend the book The Ultimate Dividend Playbook from Morningstar (written by Josh Peters).

Note from Frugal Dad: After giving it some thought, and investigating the plan with my online brokerage, I have decided to sign up for their dividend reinvestment program. Dividends will be reinvested in eligible securities held in our portfolio, allowing us to build our positions more quickly without an added fee.

Comments

  1. Thanks for pointing that out. It’s funny how often times, we just look at the dividend percent and just assume that it’s the percentage that it will alwaye be paid out!

    I’ve been thinking about the taxes quite a bit lately, and I’m thinking of moving my dividend stocks into a Roth IRA. That should take the bite out of the taxman’s teeth!

  2. I think DRIPs are an anachronism. I enrolled in a number of them many years ago. Boy was that a mistake and a PITA to get out of. I will never do that again. If you must buy individual stocks as an individual investor, better to buy from a discount broker and have them reinvest the dividends. But the preferred route is to purchase a dividend or value oriented low-cost ETF and reinvest. That way the small investor gets some diversification, and doesn’t have their financial fortunes tied to a handful of companies. Compounding is the 8th wonder of the world, but needs to be tempered by some common sense.

  3. Good article on DRIPs. They should be a part of any investment strategy that includes cash returned to the investor. That said, I’m still not impressed with the dividend investing strategy as a way to make you wealthy. A 6.5% return on investment is not impressive, especially considering the risk involved in single-stock investing. After factoring in average yearly inflation of 3%, it still beats the current rate on a CD or savings account, but not by much. The double trap of dividend investing is also this: if the stock price does go up (Yaaa!), your yield typically goes down (Booo!).

    For example: company X pays $1 yearly dividend on a share of stock that you purchased for $10. That’s a 10% yield (yearly dividend divided by stock purchase price). Let’s say that over the course of a year the stock price rises to $12 and the company raises it’s dividend to $1.02 per share. You buy another share, but this time your yield is only 8.5%. The next year the price goes to $14 and the dividend to $1.10. Your yield on this newly purchased share is only 7.8%. Granted, the first share you purchased is now yielding 11% (1% more than originally) but that’s pretty paltry compared to the fact that newly purchased share yields are down 2.2%. The gain in your share price is a one-time event and it can disappear in a market downturn.

    Bottom line is this: to assume that your investment will grow linearly like the example you give is not valid. Typically the stock price will fluctuate and with it, the yield. Therefore, it is not as “auto-pilot, stress-free” as this post assumes. You still have to review your investments at least quarterly to see what price you are paying to earn that dividend and decide if you should buy more of the same company or look elsewhere for better yields. Also, you are banking heavily on single or just a few stocks, which can and do fluctuate massively. Look at the share price of AT&T over the last 10 years. You will see it did what most single stocks did: it peaked in 2001 at about $55, twice the price that it is today, and the dividend rate today is $1.68 per share. Anyone who bought for dividends in 2001 is hating life today since their yields are a pathetic 3% on those shares.

    If you are going to invest in the market in the most auto-pilot way with the best chance of beating inflation and growing your portfolio to a size where you can enjoy retirement is (I say again) best served with growth stock mutual funds. There are funds that have a long-term (more than 30 year) history of averaging 10% or better returns. Dividend investing is fine once you’ve accumulated a pile of cash, but you need a better strategy to get that pile of cash in the first place. I don’t need a car/mortgage payment when I retire: I need a life-time full income supply. For the amount I have to invest, dividends won’t get me there.

  4. I was thinking of investing in the vanguard dividend appreciation index fund but when I compared it with their total stock market index fund it did not return the investment as well.

  5. My husband lets our dividends build up in our Scottrade account and then reinvests them along with our regular money. According to our tax stuff, we made over $250 just in dividends last year and we aren’t big investors (like <$13,000 total)…

    • $13,000.00 invested in BCE ($41.83 on the Canadian TSX ) yields 5.122% giving divident of $672.70 on 310 shares ($2.17 per year per share div.) You could easily safely double your dividends.

  6. dividend reivesting works best with long term value investing and not that day trading stuff.everybody would like a little more money but we have to be a little disciplined with income

  7. Dividend reinvesting is very important for long term growth. I recently also wrote about dividends in my blog “Improving Your Financial Health”. The article is titled “Taking Stock” and mentions companies which have raised their dividend payment for at least 25 years in a row. Coca-Cola is one of these companies. AT&T and Pfizer are not. You can click on my name to see the article.

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