I have previously written about Dividend Reinvestment Programs to illustrate the power of compounding with dividend stocks. During these reviews I looked at the Coca-Cola Company (KO), Frontier Communications (FTR), and the Procter & Gamble Company (PG). One the recurring criticisms I received was that it typically assumed a relatively high initial investment made some time ago. For example, when I looked at KO, I assumed an investor made an initial purchase of around $25,000 of KO stock in the 1970s. Without question, that is a large investment and beyond the reach of almost everyone. From a practical point of view, it would be easy to dismiss this approach and ignore the possibilities of for retirement saving.
However, one can also build up a position over time. Through both dividend reinvestment and additional recurring investments, it is possible to build a sizeable position in a given company. With this in mind, I revisited PG and assumed that the initial purchase was a more modest 10 shares or just over a $1000. While even a $1000 was significant in the 1970s, it would not be beyond the reach of such a large number of people. (Adjusting for inflation of approximately 2.5% this would be less than $3,000 in today's terms.) The secret is that this is not the end of the stock purchases. In addition to dividend reinvestment, I assume periodic investments of $200 each quarter. The total investments (excluding transaction costs and taxes paid on reinvested dividends) would be about $35,000. Basic brokerage account commissions would possibly add on another $1000-2000; although, I suspect there are other more cost effective options than executing a commissioned trade each quarter.
The following table shows how this portfolio would look today:
Chart derived from Yahoo!Finance data.
One can see that the initial investmentis quite small. Furthermore, the appreciation of the investment is also not a significant driver of the value of the final portfolio. This is despite the fact that the stock split numerous times. So many times that the initial 10 shares would be 640 shares today. Those initial shares over time produced $13k worth of dividends. The incremental shares purchased contributed another $123k and all the dividends reinvested produced another $140k of dividends - a clear sign of the benefits of compounding.
One can also see that a significant amount of the current value is driven by the appreciation of all the shares purchased from the initial investment to later purchases to dividend reinvestment. In fact, just over 70% of the current value is from this appreciation. So without question, a key aspect of this strategy is to select a quality company - one that will be around 40 years from now. However, these principles would apply to any security so one could look at a diversified ETF like SPDR S&P 500 Trust ETF (SPY) or SPDR Dow Jones Industrial Average (DIA). Alternatively, one could look at a high yield bond fund. In this case, you would expect significantly less appreciation, but more benefits from compounding due to reinvestment of interest. I personally use high yield bond funds with reinvestment in two tax deferred accounts.
So through the combination of DRIPs and recurring investments, it is possible to transform $35k into over a million dollars. The leverage in this example is time and the discipline required to make all the incremental investments. While PG has been a high performing stock for a very long time, this type of result could be achieved with lower performing securities - it just might take a little longer or require $300 quarterly investments instead of $200.
Disclosure: I am long SPY.
Additional disclosure: This article is for informational and educational purposes only and shall not be construed to constitute investment advice. Nothing contained herein shall constitute a solicitation, recommendation or endorsement to buy or sell any security.
