Dividend Farming with DRiPs

As a fan of dividend paying companies, particularly those with long histories of dividend payouts, there’s no more valuable resource I’m aware of than DripInvesting.org and its Tools page.  If you want to find dividend champions, contenders, and challengers with stable records of dividend payments, the top of the Information column on this page is the place to start.

There you’ll find a regularly updated spreadsheet listing all U.S. companies paying dividends according to the following consecutive years of dividend distributions:

•         Champions:  25 or more years
•          Contenders:  10 to 24 years
•          Challengers:  5 to 9 years

The latest update to this selection, often referred to as the CCC, is October 1, 2018.  Accordingly there are 127 Champions, 209 Contenders, and 560 Challengers on the list.  Several of the Champions have paid dividends for more than 60 consecutive years.  What’s more, you can find firms on the list that have increased their dividend payments each year for many consecutive years.

The beauty of this tool is that it incorporates far more than company name and number of years of dividend payments.  It also includes the:

•         Stock price
•          Yield
•          Last dividend increase
•          Dividend growth rate over various periods
•          Earnings per share payout ratio
•          Price to earnings ratio
•          Price to book

…and other metrics helpful in evaluating the firm’s fit to your portfolio and investing style.  In short, the CCC is a great filter to help you locate solid dividend stocks to investigate further.  The additional due diligence involves another handy dividend farming tool I’ll discuss in a future blog.

Until then, it doesn’t hurt to spend time sifting through the CCC list to get started as a Dividend Farmer.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

 

72 "Rules" - The Rule of 72

The Rule of 72 is a handy, easy-to-use tool within the DividendFarmer’s toolbox.  It’s perfect for quickly ball-parking the time required for your investment to grow to your desired level.  For instance, you may ask yourself, “Self, if I have a $10,000 dividend portfolio with a 4% yield, how long will it take for my money to double?”

If you're familiar with the Rule of 72, you’ll know that at 4%, your money will double in about 18 years.  But what if your portfolio is paying 6%?  Then your money will double in roughly 12 years.  What if your portfolio is paying a meager 2%?  Then 36 years is the general length of time needed to double your money, left to its own devices.

So how does this Rule of 72 work?  How can you quickly determine the length of time needed for your money to double based only upon the dividend yield of your stock?  Investopedia explains the Rule of 72 in mathematical terms.  If you understand logarithmic functions, the explanation hits the spot.

However, if you’re like this Dividend Farmer, you may want a less technical explanation which starts with the principle of compound interest.  If you invest $1 today at 7%, compounded annually over several years, you will have a progression that looks something like the table below.

Start	Year 1 (end)	Year 2 (end)	Year 3 (end)	Year 4 (end)	Year 5 (end)	Year 6 (end)	Year 7 (end)	Year 8 (end)
$1.00	$1.07	$1.14	$1.22	$1.31	$1.40	$1.50	$1.60	$1.71

At the end of year 8, your investment will have grown by $.71 or 71%.  This doesn’t sound like much, but it’s only a dollar and you didn’t add anything to it.  You simply waited and watched it grow much like traditional farmers do with their crops.

Using the principle of compounding and applying the aforementioned logarithmic function, an ingenious little formula was developed, called the Rule of 72, allowing you to closely approximate the length of time needed to double your money for a given interest rate. 

Behold the magic formula:    72 / interest rate (or yield) = years to double.

Using an earlier example of 6% and applying the Rule of 72 results in the following:  72 / 6 = 12 years to double.  It’s that easy.

The best part is that you can work the formula back and forth using basic algebra to find out what interest rate is required for your money to double in a given number of years.  For instance, if I want my money to double in 10 years, what interest rate do I need to earn on my investment?

If 72 / x = 10 years then 72 / 10 equals 7.2.  This conversion actually requires a little cross multiplication, then division to put x in the right place, but it works!  I need to earn 7.2%, compounded annually, for my money to double in 10 years.

It’s not uncommon for me to contemplate the length of time it might take a dividend stock I’m investigating to double in value based upon its dividend yield.  I use the Rule of 72 when I do.  And when I had a longer time horizon, I used the formula to determine how much money I might have after a 40 year work period assuming a specific interest rate compounded annually.  By-the-way, this exercise is great for fresh college grads or industrious high schoolers as well.

For instance, after 40 years of compound interest at 4% starting with $10,000, I quickly estimated I would earn in the neighborhood of $50,000.  My napkin math went something like this.  At 4%, my money doubles in 18 years becoming $20,000.  In another 18 years (36 total) it will double again to $40,000 and I’ll still have 4 years left of the original 40.  Those 4 years represent almost 25% of a third 18 year period-to-double in which case I should see close to 25% of the $40,000 added to it during those 4 years.  Consequently, I expected to see the figure grow to approximately $50,000.  Using Excel and the Future Value (FV) formula, which we’ll talk about in another post, I can work the same problem to discover my actual earnings will be $48,010.21.  Not bad for ballpark, eh?

Some caveats are in order at this point. 

First, the Rule of 72 works well until you begin talking about very large interest rates e.g., north of 50%.  However, investment returns of that scale are infrequent and probably warrant a healthy dose of caution if ever presented to you.  Better yet, run away.   

Second, the Rule of 72 works best when investments are compounded on an annual basis.  For dividend paying stocks that distribute quarterly or monthly, the approximation given by the Rule of 72 may be slightly farther off the mark, but not so far as to be of no value.

Third, the Rule of 72 doesn’t account for additional payments you make to your investment portfolio during the compounding period.  To calculate the size of your nest egg at retirement, including compound interest and infusions of money into your investment basket for example, you’ll need to use the Future Value formula in Excel I mentioned earlier.

Fourth, and very importantly, the Rule of 72 is applicable when discussing compound growth rates – thus the heavy use of the words “compound” or “compounding” in this post.  Some financial advisors may try to bamboozle you with the Rule of 72 and average rates of return which can be VERY different from the compound growth rate used as the foundation for the Rule of 72.  The compound growth rate and average rate of return are different beasts and will be discussed in another post.

There you have it.  The Rule of 72.  It took longer for me to explain than it will for you to use once you get the hang of it, but it’s a simple, invaluable tool in the Dividend Farmer’s kit.  That’s why The Rule of 72 “Rules”.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

Portfolio: October 2018

It’s time for the monthly update on my crop’s progress which is important as a Dividend Farmer.  Since the September update, there have been no major events adversely affecting my current holdings.

Although I monitor news articles and blogs for activity that might be unfavorable to my basket of stock, I’m not checking ticker prices on a daily basis.  Doing so invites a level of consternation I don’t need.  Instead, each investment is reviewed monthly to update dividend increases, price changes, and increases in stock quantities due to reinvested dividends paid during the month.

Not many changes relative to last month and no additions to principle.  However, due to dividend reinvestments in some segments, but not others, the percentages across segments have shifted slightly.  For instance, REITs were my top holding last month, but slid into second position in October.  Telco and Finance swapped rank order this month as well.  

The yield relative to current price dipped from 3.86% in September to 3.82% in October due to stock price increases across various holdings.  All dividends are automatically reinvested with no transactions fees.  Unweighted average yield on cost is approaching 4.6%; nearly 1% higher than yield on price.

The average monthly dividend from this basket is approaching $1,100.  That won’t pay all the bills, but it’ll put a nice dent in them if needed.  With a trailing 1-year CAGR of 10.6%, the long-term dividend farming strategy embarked upon 8 years ago is approaching the point of critical mass.  If you check out the Compound Growth post you’ll gain a sense of what I mean.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional. 

Portfolio: September 2018

Tracking my crop’s progress on a monthly basis is an important part of being a Dividend Farmer.  Although I casually monitor news articles and blogs for major events that may affect my investments one way or another, I’m not checking ticker prices on a daily basis.  Instead, each investment is reviewed once a month to record dividend increases, prices changes, and increases in stock quantities due to reinvested dividend paid during the month.

With that in mind, below is the September snapshot of a portion of my portfolio.  I segmented the group by industry and inserted a simple chart to demonstrate how I’ve allocated my dividend selections.

Every stock within each category is a dividend payer.  With the exception of the BDC segment, each category contains two to four different holdings.

This basket of stocks has a current dividend yield, relative to current price, of 3.86%.  All dividends are automatically reinvested with no transactions fees.  Because I’ve held most of these investments for several years, the yield on cost (initial purchase price) is actually .3% to 1.6% greater than the yield on price.  The higher yield on cost results from dividend increases relative to the initial purchase price which remains fixed. 

The total dividends from this basket is tracking to an annual run-rate north of $12,000.  It took several years to get here, but now the dividend returns are outstripping anything I can contribute to my 401K including a company match.  For instance, using $12,000, a 3% contribution, and a 3% company match, my salary would have to be over $200,000 a year to have a similar amount of money injected into my portfolio.  I’ll never command that kind of income.  Ever.  With a long-term dividend investment strategy leveraging the effects of compounding, I don’t have to.  Neither do you.  You just need to get started with the 4Things a Dividend Farmer Needs and work from there.  Food for thought…

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional. 

Average Growth v Compound Growth

There’s a world of difference between average annual growth and compounded growth.  The first figure is referenced by sellers peddling their wares; the second by investors with a clue.  For instance, one financial pro may direct a buyer toward a mutual fund sporting an average annual growth rate of 12% while another advisor might offer a product with an 8% compound growth rate.

Control what you can control: Compound interest.

People who aren’t informed, but happen to know that 12 is greater than 8 will invest in the vehicle with the 12% return while foregoing the item that “only” has an 8% figure associated with it.  All other things being equal, this is a mistake.  The reason is related to the post about the Rule of 72.

Here’s a simple example…

A stock is purchased for $10.  At the end of year 1 it has appreciated to $20.  This change represents an annual growth rate of 100%.  However, at the end of year 2 the stock’s price has fallen back to $10 representing a 50% decline in value.  The average annual return for the two years is therefore (100% -50%) / 2 which equals 25%.  However, you have the same $10 stock you started with 2 years earlier.  Doesn’t feel like 25% growth, does it?

Conversely, the compound growth rate of the stock would be 0% which accurately reflects the $0 change in value during that 2-year period.

Let’s work the math the other way.  If that same $10 stock appreciates at a compound rate of 8% over 2 years it would be worth $12.10 at the end of the period or $10 X [(1+.10)²-1].  The $2.10 change in value over the investment horizon represents an average annual growth rate calculated as ($2.10 / $10) / 2 years or 10.5%.

In both examples, the average annual growth rate is higher than the compounded growth rate.  The difference between the two calculations is fantastic for marketing and sales purposes, but not so hot if you’re buying because one percentage figure happens to be larger than another.

What does this difference mean over a longer investment horizon?  Let’s assume you start investing with $1,000 you received as a graduation gift from high school.  You have a choice between investing it for 10 years at an average annual growth rate of 10% or a compound growth rate of 8%.  At the 10% average annual growth rate, there will be $2,000 in your account at the end of 10 years.  You will have doubled your money.

However, if you invested it at an 8% rate compounded annually you would have $2,158.92 earning $158.92 more than you would have with the alternative.  Maybe this doesn’t sound like much of a difference to you, but when you extend the math out to 20, 30, or even 40 years of an investing life, the delta in ending values is significant.

As I’ll mention in a related post, the Rule of 72 is based upon a compound growth rate; not an average annual growth rate or average return.  There are investment advisors out there touting average annual growth rates and using them in relation to the Rule of 72.  Whether this is done out of ignorance or avarice is debatable but in either case it’s wrong and you should be aware.  Caveat emptor, indeed!  It’s better to understand in advance what’s going on than find out years later and thousands of dollars stranded on the table that you didn’t know your financial math when you plunked down your money.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.

Compound Growth

Wisdom!

Growth is good.  Compound growth is better.  A related post outlines the difference between average annual growth and compound annual growth.  In this piece, I wanted to explore the benefits of compound growth in more depth.

One important characteristic of compound growth investors often find difficult to wrap their heads around is that compounding isn’t a straight line path to a wonderful stream of cash.  The greatest effects of compounding don’t happen right away, but at some point in the future.  The growth rate of a compounding investment accelerates over time producing a curvilinear path rather than a straight line.  This curve appears somewhat exponential, but isn’t exactly. 

While this type of curve produces solid results, it requires patience to stay the course until reaching the inflection point on the growth curve; the point at which compounding really begins to take off.  Unfortunately, many investors don’t stick with it until that acceleration point is reached, bailing out before harvesting the true gains they might have otherwise.

Here is an example of what I mean.

In this example, an investor started with $1,000.  She put her money into a dividend stock having a distinguished history paying 8% annually, letting dividends automatically reinvest each year.

You’ll notice that at the end of Year 1 she received $80 in dividends so we’ll call that 1x.  In Year 10 she received $160 dollars which was twice what she received in Year 1 so we’ll call that point 2x.  In Year 15 she received $234 which is nearly three times her Year 1 dividends in which case we’ll call that data point 3x.  Year 19 saw our investor receive $320 which is four times her Year 1 dividends so we’ll refer to that point as 4x. 

Since you get the drift, I won’t use more words, but instead post a chart.

Dividend Multiples	Years
1x	1
2x	9
3x	15
4x	19
5x	22
6x	24
7x	26
8x	28
9x	30

You’ll notice it took our investor 8 years to double her year 1 dividends, 6 more years to triple those divs, 4 additional years to quadruple them, and three years to reach 5x.  After that, she added another multiple to her original payment every 2 years. 

In the first 15 years her dividend stream compounded to triple her year 1 total.  In the second 15 year period, she saw the effects of compounding take off with her annual dividend multiple reaching 9 times hear year 1 dividend payment. 

This is what I mean about the powerful effect of compound growth not occurring out of the gate but somewhere down the track.  Consequently, it’s important for investors to stay the course.

It’s important to begin investing early and letting compound growth work for you for this reason.  If you’re a young investor or you have small children who’ll need college money in 15 to 20 years, you can do yourself a favor by putting money away early, even if it’s not a large sum.  Compounding can take a small sum and turn it into something big in the end.

By the way, if you’re wondering what the underlying principle was at various points along the way, below is a chart in which I’ve added that data.  Notice that during the 30-year period her final total is more than 10 times her original value.

Dividend Multiples	Years	Principle
1x	1	$          1,080
2x	9	$          1,999
3x	15	$          3,172
4x	19	$          4,315
5x	22	$          5,436
6x	24	$          6,341
7x	26	$          7,396
8x	28	$          8,627
9x	30	$        10,062

Having said all that it’s true that not all dividend stocks pay 8%, nor can you be guaranteed they’ll pay out at that rate 3 decades into the future.  It’s also true that inflation will eat into the figures above.  Although nothing in life is guaranteed, some things are more likely to occur than others.  Dividend streams from solid, blue chip dividend companies are about as reliable as you’ll find in the investing world.  If they remain consistent and you are patient, the math of compounding will take care of itself and you.

The thoughts and opinions expressed here are those of the author, who is not a financial professional.  Opinions expressed here should not be considered investment advice.  They are presented for discussion and entertainment purposes only.  For specific investment advice or assistance, please contact a registered investment advisor, licensed broker, or other financial professional.