Compounding Dividends = Financial Power

I’ve posted multiple times about the power of compounding dividends.  Previous posts are below.

• Compounding Periods:  The more the merrier
• Average Growth vs Compound Growth
• Compound Growth
• 72 "Rules" - The Rule of 72
• Powerful Investment Growth with Compounding
• Would you Rather?

Dividend compounding offers extraordinary financial power if allowed to work over a period of time.  If the posts above aren’t sufficiently convincing, maybe the information below will be.

In many cases 1% doesn’t make a difference.  If I get 1% more cereal in a box from vendor A than I do from vendor B for the same price, I may not care.  Should one filling station charge 1% more for a gallon of gas than another, I’ll pay 2-3 cents more per gallon.  Not an inconvenience.

One percent can make a world of difference in your financial life, though.   The chart below demonstrates outcomes for dividend yields of 1% to 8% compounded quarterly for 20 years.  The beginning balance was $1,000.

In this chart, the only addition by an investor is the original $1,000.  Anything beyond that is due to the effects of compounding over time.  Excel’s FV function was used to determine the results.  Investopedia’s CAGR calculator offered a double-check.

The growth curve across the yields is impressive.  The important fact to note is that for each 1% increase in yield, the result was more than double that of its predecessor.  For instance, the tally at 2% is just more than 2x that of the 1% outcome.  That sounds logical given the fact that 2 is twice as great as 1.  However, the total at 5% is more than twice that of 4% as well, despite the fact that 5% is marginally greater than 4%.  The same holds true at 8% relative to the 7% outcome.

The importance of increasing portfolio yield by small amounts is adequately demonstrated.  What happens if the yield is held constant, but the compounding periods change?  The chart below shows that as well.

As with the first chart, Excel was used to generate the outcomes and double-checked using Investopedia’s CAGR calculator.

In this case, a 4% yield was used for a 10-year period vs 20 in the prior example.  $1,000 was the nest egg with which to start.  No additional funds were added by the investor.  The only variable changed was the number of compounding periods within the 10-year horizon. 

Notice the large jump when moving from quarterly compounding to monthly compounding.  Increasing the number of compounding periods within an investing time frame may be as powerful as increasing the length of the investing time frame.

In other words, investing in stocks paying dividends frequently is nearly the same as being gifted extra years in which to invest and keep ‘em compounding.

In a nutshell:

1) Each 1% increase in dividend yield can more than double the result over 20 years.  Therefore, increase the yield when possible.

2) Investing in dividend stocks paying monthly dividends is superior to stocks paying quarterly or less, other things being equal.  Consequently, look for solid stocks paying monthly dividends.

3) The longer the investing horizon, the greater the total growth.  Start investing early and keep at it.

 

If you find a Dividend Champion or Dividend Aristocrat consistently growing its dividend and do so early in your investing career, you may reap the benefits of all three points while doing little more than holding on and enjoying the ride.  If you can add to the investment pool as you go, things accelerate further.  That’s why compounding = financial power; the power to be financially free.

 

In the immortal words of one of history’s most intelligent men:

“Compound interest is the eighth wonder of the world.  He who understands it, earns it… he who doesn’t, pays it.” – Albert Einstein

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