In its simplest form, banks make money from borrowing the money in your savings account and lending it to someone else. Ok, they do pretty good with the "gotcha fees" as well. For the sake of this article let's focus on the borrowing and lending part. For example, a bank pays you 1% for the money in your savings account and lends it to someone else at 6% for a home loan. The 5% difference is the spread. 5% doesn't seem like that big of a deal, but the longer the home loan's duration the more they make in interest. This is the miracle of compounding, for the bank.
The easiest way to grasp this is to look at a 30 and 15 year mortgage.
|Loan Amount||Terms||Interest Rate||Interest Paid||Total Paid|
The easiest $50,000 a bank can make is talking you into a 30 year mortgage over a 15 year. How can you turn the tables and become the banker?
Find a few dividend stocks. Best yet, a few dividend aristocrats. These companies have increased dividends over 25 years in a row. Your dividend aristocrat needs to be able to do the following:
1. Have profits/cash flows that are sustainable
2. Increase dividends at a steady pace, preferably over 5% annually
3. Have a payout ratio that is sustainable, preferably under 60%
Now, to really make this work and become the banker you need to follow these steps:
1. Fine these companies early in your investing career
2. Collect the dividends and re-invest them
3. Repeat steps 1 and 2 over and over again
Many of the companies that fit into this criteria are S&P 500 companies such as:Johnson and Johnson (NYSE:JNJ), McDonald's (NYSE:MCD), Wal-Mart (NYSE:WMT), Exxon Mobile (NYSE:XOM), and HCP, Inc. (NYSE:HCP). The following table shows current yields, 5 year dividend growth rates, and 5 year share price growth rates of these 5 companies.
|Stock||Current Yield||5 year DGR||5 Year Price Growth Rate|
The following table illustrates an initial $1,000 investment in the average of these 5 stocks over a 30 year timeframe.
|Dividend Growth Rate||8.96%|
|Stock Price Growth Rate||7.12%|
|Ending Balance w/Dividends Reinvested||$26,519.00|
In 30 years your $1,000 investment is now worth over 25 times as much. That is being the banker. You can run your own simulations of reinvesting dividends here. These 5 stocks were selected because they are on the dividend aristocrat list, are from different sectors, and are a good combination of stock price growth vs. dividend growth.
Using this approach, market timing becomes much less important. You may buy stocks hundreds of times while you are investing before retirement and that will serve as a way to average out purchase prices. Getting started early is the real key to success.
For more information on dividend increasing stocks please read some of the articles written by David Fish. His expertise in this area is second to none. The whole SA community can/does benefit from his work.
Disclosure: I am long JNJ, XOM, MCD, HCP, WMT. 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.