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Summary

  • Dividend growth investing is a great investment tool for youth to use.
  • Case study of a young investor building their portfolio over time using dividend compounding.
  • Young investors can take advantage of compounding over long periods of time.

Regarded Solutions recently wrote an article titled, Retirement Strategy: How Dividend Income Grows To Staggering Levels By Reinvesting And Compounding. In his article, he touches on the growth of dividends, and how over time, these dividends (if re-invested) will continue to compound, providing a solid income stream for retirees. In his example, he uses the time frame of 10, 15, and 20 years for re-investing and compounding to grow the income stream. In this article, I am going to take his "case study" and discuss how a young investor can benefit from using this strategy.

Touching on Risk

Firstly, I will start out by classifying young investors as anyone under 25, and the main target is people aged 19-25. Just like my last article about setting up the young person's portfolio, I would like to stress that just because you are young it does not mean that you need to take additional risk. It is widely agreed upon that young investors have the time to incur losses in their funds, and that they are able to take additional risk. Although this statement is true, I still do not believe in this approach to investing. In the comment section of the article entitled "Setting up the Young Person's Portfolio," one person suggested that young people do not know enough to stock pick. I do not believe this to be true, however, lack of knowledge among young people will make picking value growth stocks may be an arduous task. Dividend growth investing allows young investors to choose widely known companies, and enables the company's dividends to re-invest and compound over a long period of time.

Compounding

Compounding is more effective when the time frame is longer, and it is often called one of finances most powerful concepts. The sooner one begins to use compounding as their investment strategy, the longer the funds can be 'put to work.' Since this is intended for young investors, my sample case will be different than Regarded Solutions. For this example, I am going to assume that the investor is 25 years old, and the intention is to retire at the age of 65. I am also going to assume that they begin with $10,000.00 to invest, with annual savings of $2,500.00 to age 35, $5,000.00 to age 45, $7,500.00 to age 55, and $10,000.00 until retirement. I am focusing on a young investor who contines to save a specified amount of money each year to fund their retirement. A 5% dividend growth is a conservative measure to show investors the value of compounding, and how it can be used to increase wealth over time.

    

Initial Yield: 2%

Initial Yield: 2%

Initial Yield: 2.5%

Initial Yield: 2.5%

Year

Years Compounded

Investment Annually

Initial Share Count

*Share Count After 40 Years

*Total Value After 40 Years

**Share Count After 40 Years

**Total Value After 40 Years

Initial

40

10000

200

2,291

$114,574

4098

$204,884

1

39

2500

50

502

$25,108

871

$43,555

2

38

2500

50

443

$22,139

746

$37,302

3

37

2500

50

393

$19,632

643

$32,168

4

36

2500

50

350

$17,503

558

$27,922

5

35

2500

50

314

$15,686

488

$24,391

6

34

2500

50

283

$14,128

429

$21,435

7

33

2500

50

256

$12,784

379

$18,947

8

32

2500

50

232

$11,622

337

$16,840

9

31

2500

50

212

$10,610

301

$15,048

10

30

2500

50

195

$9,728

270

$13,514

11

29

5000

100

358

$17,907

488

$24,393

12

28

5000

100

331

$16,545

442

$22,117

13

27

5000

100

307

$15,342

403

$20,143

14

26

5000

100

286

$14,276

368

$18,424

15

25

5000

100

267

$13,328

338

$16,920

16

24

5000

100

250

$12,483

312

$15,599

17

23

5000

100

235

$11,727

289

$14,435

18

22

5000

100

221

$11,048

268

$13,406

19

21

5000

100

209

$10,437

250

$12,492

20

20

5000

100

198

$9,886

234

$11,679

21

19

7500

150

282

$14,082

329

$16,428

22

18

7500

150

268

$13,405

309

$15,452

23

17

7500

150

256

$12,789

292

$14,575

24

16

7500

150

245

$12,229

276

$13,785

25

15

7500

150

234

$11,717

261

$13,072

26

14

7500

150

225

$11,249

249

$12,426

27

13

7500

150

216

$10,821

237

$11,840

28

12

7500

150

209

$10,428

226

$11,307

29

11

7500

150

201

$10,066

216

$10,821

30

10

7500

150

195

$9,733

208

$10,377

31

9

10000

200

251

$12,568

266

$13,295

32

8

10000

200

244

$12,190

256

$12,799

33

7

10000

200

237

$11,840

247

$12,343

34

6

10000

200

230

$11,516

238

$11,923

35

5

10000

200

224

$11,215

231

$11,537

36

4

10000

200

219

$10,936

224

$11,180

37

3

10000

200

213

$10,677

217

$10,851

38

2

10000

200

209

$10,435

211

$10,545

39

1

10000

200

204

$10,210

205

$10,263

40

0

10000

200

200

$10,000

200

$10,000

Total:

 

260000

5200

12695

$634,599

17410

$870,433

* All calculations assume a 5% dividend growth rate

** All calculations assume dividends are re-invested

***All numbers are rounded for simplicity

There is no capital appreciation included in these calculations and each year a new position is initiated.

The following calculator as found in Regarded Solutions' article can be found here.

The Results

In both mock scenarios, investors are able to increase their wealth tremendously simply by allowing the dividends to be re-invested and compounding their returns over time. At the end of the mock portfolio performance over 40 years, investors overall wealth allows them to shift their investments to higher yielding stocks to help generate the necessary income during retirement. This example was meant to illustrate the value of compounding especially for the young investor. In addition, the sooner one invests in this concept, the more time they have to reap the rewards from compounding. As shown, investments of less money earlier in time turns into higher returns than larger investments in later years. Please note with that this dividend growth, combined with price appreciation over the specified time period, investors are well on their way to setting up for retirement. I do not believe that companies will be able to increase their dividends at 5% annually if they cannot increase earnings, which usually (but not always) increases stock prices. If young investors are able to find companies that have a reasonable initial yield (2-3%) with a high dividend growth rate, they will be able to grow their funds at a faster rate than shown in the example. The Coca Cola Company yield about 10 years ago was around 2%. It has grown its dividend annually between 6-13% (Robert Allan Schwartz's website is awesome), seeing its yield at around 3% and increasing wealth for shareholders.

My Take on Dividend Growth Investing

This philosophy is what has made shareholders of The Coca Cola Company (NYSE:KO), Procter and Gamble (NYSE:PG), Pepsico (NYSE:PEP), Exxon Mobil (NYSE:XOM), and many others, extremely happy (and wealthy) over the years. As an owner of a business, I feel that I should get my share of profits, and dividend investing allows for this to happen. Companies can only continue to grow their dividends at a reasonable rate if they continue to increase or maintain high profits and cash flow. Compounding works best when given more time to allow the funds to compound. If young people are able to save money, and let their savings compound over a long period of time, I think they are putting themselves in a good position for retirement. Too many young investors feel that they can take a great deal of risk when they are young (largely part to what they are told), and ignore one of finances most powerful concepts --- compounding.

Source: Young Investors: Let Compounding Do Its Work

Additional disclosure: A family portfolio that I help manage is long PG, PEP, and XOM. Calculations do not include any capital gains which does impact the total value of portfolio over time.