The key to building up a solid net worth isn’t just the accumulation of numerous assets. There also needs to be a level of passive income that gets generated so that wealth can continue to grow over time. By using the dividend growth model strategy, an investor is able to build up their assets while encouraging passive income development.
This is how true wealth is achieved.
When you’re working on Dividend Growth Investing, what you’re really doing is purchasing dividend stocks that are anticipated to grow over a specific period of time. Investors will hold onto these investments in order to continue collecting the dividends and this creates the passive income that they need to build up their net worth.
A common mistake that beginners make with Dividend Growth Investing is that they will look solely at stocks which offer high dividend yields. Those stocks are an essential part of the overall passive income equation, but they can’t do the job on their own. Companies that grow their dividends annually must also become part of the portfolio.
Just ask someone who hasn’t had a raise since 2009. Income isn’t really valuable or impressive unless it has the ability to grow in some way.
When used over the course of a long-term strategy of investment, and assuming that the companies you’re investing into are able to stay relatively healthy and post profits, then your passive income will continue to increase due to the dividends that are being paid out. Then you can just reinvest those dividends into more stocks that have consistent payouts to keep building. This strategy works because growth is exponential and requires a complete failure of every company in a portfolio to not work.
What Companies Pay Out Dividends?
A company that makes a profit is a company that may decide to pay a dividend. Companies often decide to invest into their core strategies first and pay off large outstanding debts second. After those needs are resolved, dividends are a classic method of providing investors with some income. Since shareholders are essentially equity owners of a company, there is a certain expectation to get paid. Regular dividends are a way to do this.
In using a dividend growth strategy, investors are going to want to look at companies that are able to post consistent profits within their industry. Popular industries, like telecommunications or utilities, may provide more companies from which to choose, but it is also important to remember that past results are not a guarantee of future growth. A company with a history of profits, followed by dividend payments, is a great place to get started when purchasing shares for the first time.
Once purchased, shares of a company can be held for an indefinite period of time. This allows investors to continue receiving some income year after year – and potentially fiscal quarter after fiscal quarter.
What Do You Need to Know About Dividend Growth Investing
When you’re first getting started in the world of investing, it can be a little hard to figure out what some people are talking about when analyzing the potential of a stock. Here are some of the common terms that are used that you’re going to want to know about.
Dividend Yield: Each share is a specific portion of equity that someone is able to hold in that company. The dividends that are paid out reflect the exact percentage of the company that an investor owns. If someone owns 1% equity with their shares, then they’ll receive 1% of the dividends that are paid out to all shareholders. The yield is how much of a dividend that is given in relation to the price of stock when purchased. If a stock is purchased for $100 and that share pays $5 in cash annually, then the dividend yield would be $5%. Those figures then can be multiplied exponentially to determine anticipated passive income.
Dividend Growth Rate: This term refers to how fast the dividends are growing so that the passive incomes can continue to expand. Most companies will increase their dividends annually, which means an investor’s passive income will be naturally larger every year. Some organizations have shown long-term dividend increases over the course of 50 consecutive years. It is important to remember, however, that the dividend growth rate will not be the rate of return. With a growth rate of 10%, a $1 per share dividend today will be a $17 dollar per share dividend in 30 years.
Dividend Payout Ratio: This term refers to the amount of per-share earnings that are paid out to shareholders every year. By knowing what the earnings per share [EPS] happens to be, then this ratio can be easily calculated. Let’s say that a company reports an EPS of $4 per share. The decision is made to pay a dividend of $1 per share. This would create a dividend payout ratio of 25%. One quarter of the profits are going back to the shareholders and three-quarters of the profits are going toward other business ventures. A higher dividend ratio lets investors know how safe a dividend happens to be and what the growth potential of an organization happens to be.
How Does the Math of the Dividend Growth Model Work Out?
Dividend Growth Investing is a long-term wealth proposition. It works because the initial investments begin to accumulate and become worth more over a longer period of time. In a best case scenario of a company that has 8% annualized growth over the course of 40 years and starts an investor with a $1 dividend, a $3,000 investment can become worth over $220,000 over four decades of investment power. Assuming 100 shares at the $1 mark and consistent reinvestment of dividends, the annual dividend income can go from $100 to over $7,000 in the same period of time.
This doesn’t take inflation into account, of course, so the figures being put into place here will have less value than today’s money. It may also mean that there would be higher values in the final figures after 40 years.
That’s just one investment of $3,000 being made using Dividend Growth Investing as a strategy. Now imagine making 4 similar investments over the course of three years. A total investment of $36,000 would not only be generating passive income annually that would eventually build into passive income of over $100,000 annually in 40 years.
More impressively, the total value of the investments would be worth just under $3 million.
That’s why it is never too late to start investing. Although long-term investments tend to pay off better and more consistently, building real wealth through passive income can easily secure a retirement. Anyone can begin investing today. Will the dividend incomes be something that you can live off of immediately? No. Will you be setting up the foundation of a solid net worth that will leave a lasting family legacy? Absolutely.
The Best Way to Grow Passive Income Is to Reinvest Dividends
In the early days of investing, your dividends are going to be minimal at best. If there’s an emergency, then there’s a little extra income that could be available. The best solution, however, is to reinvest as many of the received dividends as possible. With a disciplined mindset, picking good companies to begin a cycle of investment that could pay off with a net worth of millions over the years is a very real possibility.
To make that happen, you’ll eventually need to be building a portfolio through the purchase of more shares. If you’re living on a tight budget, the dividends become a free source of money that can be used to continue building wealth. The difference in real wealth can be massive when dividend reinvesting is compared to dividend spending.
Using the example from above, let’s say that two investors have $50k to invest instead of just $3k. One of the investors spends the received dividends when they come in while the other investor reinvests all of the dividends. For the first decade, there’s almost no difference in the net worth of the investors. It isn’t until around Year 17 that real gaps begin to form. By the end of Year 40, that gap has expanded to over $2 million.
It takes time to use dividend growth investing as a strategy. It isn’t going to provide an investor with short term result. It will take 17 years to really start to see huge gains from an investment – and that’s assuming consistent annual growth in this example. That’s why getting started right now is so important. Eventually a household can live off of the dividends from the accumulated wealth of investments. If you’re starting with a low amount, it will take time to build those funds up.
It is, however, something that anyone can do. With reasonably priced stocks, an ability to understand a company, and a strong balance sheet, a company can provide an impressive growth strategy for an investor. That’s why the dividend growth model is one of the most important aspects of a solid long term net worth.