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After the Great Recession crash of 2008 the subject of dividend investing has, without a doubt, become one of the most popular topics in recent times. Following the crash, investors increasingly shifted to safe investments such as bonds, CDs, and cash. However, after years of record low treasury yields that do not keep ahead of inflation rates, many investors are beginning to feel the squeeze. They have finally begun fleeing the bond market to seek a higher yield. This fundamental supply and demand concept has resulted in money starting to flow and has boosted the stock market to near all-time highs again.

The increasing demand for higher-yielding equities, either through higher-paying dividend stocks or capital appreciation, has fueled the flight from CDs and bonds to equities. Investor appetite to boost their income and yield has been extraordinary. However, there has not been much discussion about the best way to maximize a particular investor's portfolio value and income as it relates to his individual stage in life.

The answer lies within an investor's time horizon. Most financial advisors seek to find the highest dividend yield accompanied by a high degree of safety. The problem with this is that the advisor does this in order to show his clients increased value in the short term as well as to receive a higher commission. This could be fine for an elderly couple in their 70s who have a life expectancy of approximately another 10 years. The safety and highest income possible are absolutely their main concerns, or at least should be.

There is not enough time at their stage in life to be invested in lower-yielding stocks with higher dividend growth rates. If they chose this path, the continuing yield would be relatively small, under 3 or 4 percent for the remainder of their retirement, with little time for the compounding effect to have much impact on their income stream and keep them ahead of inflation.

Table 1. (The Older investor)

Johnson and Johnson (NYSE:JNJ)

Dividend Reinvestment Calculator

Initial Number of Shares:

130

Initial Price per Share:

$ 77

Annual Dividend:

$ 2.44

Dividend Annual Growth Rate:

8 %

Stock Price Annual Growth Rate:

5 %

Number of Years:

10

Calculator Results

Without Dividend Reinvestment

With Dividend Reinvestment

Total Value

$21,109.17

$23,327.97

Number Shares

130

187.82

Dividends Paid

$4,962.75

$5,973.41

Annualized Return

7.85 %

8.94 %

In Table 1 above, for Johnson and Johnson , we assume:

  1. $10,000 initial investment
  2. 3.2 percent current dividend yield
  3. 5.0 percent dividend growth rate
  4. Ten years in retirement

Table 2. (The Older investor, continued)

Apollo Investments (NASDAQ:AINV)

Dividend Reinvestment Calculator

Initial Number of Shares:

1190

Initial Price per Share:

$ 8.90

Annual Dividend:

$ .80

Dividend Annual Growth Rate:

0 %

Stock Price Annual Growth Rate:

5 %

Number of Years:

10

Calculator Results

Without Dividend Reinvestment

With Dividend Reinvestment

Total Value

$26,771.62

$33,735.64

Number Shares

1,190

2,327.05

Dividends Paid

$9,520.00

$13,467.75

Annualized Return

8.72 %

12.28 %

In Table 2 above, for Apollo Investments , we assume:

  1. $10,000 initial investment
  2. 9.6 percent current dividend yield
  3. 0 percent dividend growth rate
  4. Ten years in retirement

Analysis

As the tables above indicate, the annualized average returns and dividends are much greater when investing in higher-yielding quality stocks as opposed to lower-yielding, increasing dividend stocks. Therefore, it is imperative for the investor in his retirement to remain in mostly high-quality dividend yields such as AINV in order to maximize his dividend income as well as portfolio value.

How about the middle-aged investor?

Where does he fit in this equation? An individual who is 50-years old and is expecting to live another 25 years or so should not be focused primarily on the highest yield. This will not maximize his future income, as well as his portfolio value in the end. Middle-aged investors certainly do need to be shifting to safer investments as they near their retirement. They do not want a crash to wipe out their hard-earned savings and investments.

The optimal strategy for the investor in this stage of life is a blend of high yielding safe stocks such as Prospect Capital (NASDAQ:PSEC), Apollo Investments and Main Street Capital (NYSE:MAIN) as well as dividend growth companies such as Johnson and Johnson . Since middle-aged investors do not have enough time for the full effects of compounding to take place, they will optimize their value, yield, and safety with a diversified blend of high-dividend growth stocks and higher yielders.

Table 3. (The Middle-Aged Investor)

Apollo Investments

Dividend Reinvestment Calculator

Initial Number of Shares:

1190

Initial Price per Share:

$ 8.90

Annual Dividend:

$ .80

Dividend Annual Growth Rate:

5 %

Stock Price Annual Growth Rate:

5 %

Number of Years:

25

Calculator Results

Without Dividend Reinvestment

With Dividend Reinvestment

Total Value

$59,64.89

$122,987.00

Number Shares

1,190

4,080.72

Dividends Paid

$23,800

$51,490

Annualized Return

7.16 %

10.31 %

In Table 3 above for Apollo Investments , we assume:

  1. $10,000 initial investment
  2. 9.6 percent dividend yield
  3. 0% dividend growth rate
  4. 25 years in retirement

Table 4. (The Middle-Aged Investor, Cont.)

Johnson and Johnson

Dividend Reinvestment Calculator

Initial Number of Shares:

130

Initial Price per Share:

$ 77

Annual Dividend:

$ 2.44

Dividend Annual Growth Rate:

5 %

Stock Price Annual Growth Rate:

5 %

Number of Years:

25

Calculator Results

Without Dividend Reinvestment

With Dividend Reinvestment

Total Value

$49,793.40

$73,939.98

Number Shares

130

283.57

Dividends Paid

$15,895.99

$25,544.07

Annualized Return

6.63 %

8.33 %

In Table 4 above for Johnson and Johnson , we assume:

  1. $10,000 initial investment
  2. 3.2 percent current yield
  3. 5.0 percent dividend growth rate
  4. 25 years in retirement

Analysis

The results reveal that by investing in the higher dividend paying stock, we will generate more dividends, income, and arrive at the highest portfolio value. However, with a blend of both worlds of quality dividends, we use the high dividend growth company as our safety net, and use our higher dividend yield company as our initial driver of our portfolio growth. Hence, it is a more balanced dividend portfolio containing slightly greater risks with the higher-yielding stocks.

What's in store for the young investor?

For the young investor, the ultimate way to maximize portfolio value and income is to mainly invest in high dividend growth stocks and continue to invest as much as possible into this strategy as I mentioned in one of my previous articles. Although somewhat "boring" in the beginning, the effects of compounding become tremendous. Therefore, there is no need to swing for the fences in order to impress anyone. With patience, the feeling of making a home run will multiply tenfold.

It is no wonder that Albert Einstein proclaimed that 'compounding is the most powerful force in the universe.' The young investor who is able to think ahead and appreciate Einstein's fascination with the power of compounding will thank the stars and count his lucky bucks, one dividend check at a time, and enjoy the freedom to do what he pleases in his retirement years.

Table 5. (The Young Investor)

Johnson and Johnson

Dividend Reinvestment Calculator

Initial Number of Shares:

130

Initial Price per Share:

$ 77

Annual Dividend:

$ 2.44

Dividend Annual Growth Rate:

3.2 %

Stock Price Annual Growth Rate:

5 %

Number of Years:

40

Calculator Results

Without Dividend Reinvestment

With Dividend Reinvestment

Total Value

$158,530.43

$715,011.32

Number Shares

130

1,331.99

Dividends Paid

$88,746.55

$444,220.30

Annualized Return

7.18 %

11.29 %

In Table 5 above for Johnson and Johnson , we assume:

  1. $10,000 initial investment
  2. 3.2 percent current yield
  3. 5.0 percent dividend growth rate
  4. 40 years until retirement

It is clear from the tables above that reinvesting is vital. So is the time horizon involved. This is without a doubt the ultimate route for the young investor seeking to optimize his dividend income as well as his portfolio value. The main ingredients to accomplish this goal are patience and discipline. This recipe requires continuing investment of both excess cash and reinvestment of dividends received throughout one's career.

In basic programmer language it would look something like this:

100 Invest excess cash on a regular basis

200 Reinvest all dividends received

300 Go back to 100 and repeat

This recipe will yield a very high degree of happy returns and tasty satisfaction in retirement.

Read more about this in one of my previous articles about compound dividend investing.

Mitigate risk with diversification

Of course, to mitigate risk in this, or any portfolio, it is essential to diversify within this strategy, spreading the risk by buying stocks in various industry segments, as well as small-caps, mid-caps and large capitalization companies. Filling out the portfolio with 30 to 40 names should sufficiently minimize risk, even if any one company reduces or eliminates its dividend from time to time. If such a reduction makes a significant impact, you may decide to sell that company and replace it with another that provides similar characteristics. Or, if there is no material change in your view of the company, you may decide to buy more at a lower price, thereby increasing your yield and your income once again.

With 40 names in the portfolio, even if one stock suffers a blood bath and loses 20% on a given day, this by itself would only represent a ½ percent hit to the overall portfolio:

(100% of your portfolio divided evenly over 40 names= 2.5% invested in each name X 20% hit to one name= .5%)

If you owned only one stock that suffered such a loss, you'd have lost 20% of your entire equity at risk. Owning 40 stocks reduces the pain to just ½ of one percent and it becomes easily bearable. Ah, the magic of diversification.

Combining the magic of diversification with the magic of compounding by dividend reinvestment is clearly a winning combination.

I would be glad to hear from readers of all ages with your comments and dividend investing strategies.

Source: Compound Dividend Reinvesting Plus Diversification Equals Secure Retirement