The Tipping Point Of Dividend Investing

by: Eli Inkrot

Recently I finished reading the book: "The Tipping Point: How Little Things Can Make a Big Difference" by Malcolm Gladwell. Within this text the author describes how seemingly small and sometimes even innocuous events can have large impacts over time. Gladwell argues that any well-known idea, trend or social behavior starts small, reaches a threshold and then "tips" to spill over to the masses. Think of a single sick person eventually causing a flu epidemic for instance.

Given that my frame of thought tends to shift towards the business world, it occurred to me that certain "tipping points" existed within the realm of dividend investing. First and foremost, you're reading this article. So if you practice an investing strategy that incorporates collecting dividends it follows that you have previously had an initial "tipping point" to get you interested. Perhaps you first found out about dividend growth investing in a book or noticed that Berkshire Hathaway (NYSE:BRK.B) happens to own quite a few dividend paying companies.

Once an investor begins the dividend journey, I would further contend that there are three more "dividend tipping points" along the way. The first point is what I like to call "getting the dividend bus rolling." When thinking about one's eventual goal it can be disheartening to see $0 in dividend income coming in with an ultimate goal of say $25,000. It seems that the task is too large and there might be a natural tendency to write it off as impracticable.

Moreover, even if you start out on this path - by diligently saving up your first $1,000 to invest for instance - the initial dividend fruits aren't especially reassuring. Eight dollars a quarter or whatever it happens to be isn't exactly going to keep the lights on. Despite delaying gratification, you still have to go to work, you still have to keep expenses in check and really if you're just starting to accumulate investing funds then the process might even be more difficult than before; not easier. If you don't elect reinvest the dividends, being able to buy an extra ice cream cone each month doesn't appear to be much of a reward for giving up access to $1,000.

So the first "dividend tipping point" is realizing that small amounts can eventually aggregate to large sums - understanding the "magic of compounding" and all that jazz. Now I could provide some mathematical examples, but I think a real life illustration will better illustrate the point. Let's imagine that you had $1,000 to invest at the end of 1994 and decided that IBM's (NYSE:IBM) prospects looked pretty solid. Here's what your dividends would look like on a yearly basis:

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In the first year you would have received $13.60 in dividends and to be perfectly frank I'm not even sure if you could have enjoyed that monthly ice cream cone that I previously referenced. But look what happens next: your dividend income just keeps on rising and last year you would have collected over $200 due to that initial $1,000 investment. Surely this isn't "quit your job" money, but it is apparent that small amounts can turn into larger amounts over time. Moreover, you would have received 1.3 times your initial investment in the form of dividends in addition to some nifty capital appreciation along the way.

If you get discouraged early on, you might use this trick to think about income streams: focus on what expenditure this passive income could cover. For instance, if you have a $2,000 investment in Kimberly-Clark (NYSE:KMB) generating $62 a year in income it might be easy to dismiss this as barely productive. However, if you think about in these terms: "Ok, I now have a lifetime supply of Kleenex tissues and Cottonelle toilet paper through my ownership claim in a wonderful company" then your frame of thought might change.

The next "dividend tipping point" is when your passive income becomes sustainable in its own right. Charlie Munger earmarked this as a portfolio value of $100,000 while fellow Seeking Alpha author Tim McAleenan has updated this line of thinking by indicating: "You Become A King When Your IRA Hits $150,000." Let's imagine you have been diligently saving and investing to reach a portfolio balance of $100,000. With a current yield of 3.65% this would indicate yearly dividend income in the amount of $3,650. Said differently, you would be getting $10 for each day that you wake up in the morning - in effect guaranteeing yourself security from hunger no matter what happens elsewhere. Furthermore - if reinvested - your dividend income is now making more passive income than the first tipping point example. At this point you could not invest another dime and have a reasonable shot at seeing 5 figures of passive income come your way in the next couple of decades.

Finally - and I'm sure you saw this coming - the last "dividend tipping point" is when your passive income eclipses your expenses. It might seem like I'm a missing a few steps, but those basic points are really the most defined in a dividend investor's journey: becoming aware, begin / keep investing, using income to fuel income and reaching financial satisfaction. As a supplement to this, I thought it might be interesting to highlight a few people that have completed or are close to making this final "tip." I've previously highlighted some of these sites, but accounts like these can form a much better picture than I could in a single article.

Pete who runs the blog 'Mr. Money Mustache' and Jeremy and Winnie at 'Go Curry Cracker!' were both able to retire in their 30's and are currently living off passive income. Surely your personal goals might be different, but we can all learn quite a bit from their stories.

Or Jason at 'Dividend Mantra' and Johnny at 'Johnny Moneyseed' both intend on reaching financial independence in the next decade. Perhaps you'll join them in this expedition.

The bottom line is that everyone reading this article has already accomplished the first "dividend tipping point" by being aware. Next, I would surmise that the large majority of you have begun investing and are well aware of the benefits of time and effort. Finally, it's difficult to discern the percentage of readers that have reached the final two "tipping points" but I would image that there's a reasonably sized group of you out there. Yet regardless of where you currently stand, it should be refreshing to know that this type of investing strategy tends to build upon itself. So how about you, have you begun to break through thresholds and "tip" into higher passive income goals?

Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.