The rise and fall of stock prices can get a lot of attention, but dividends can play a big part in an investor’s overall return. With Dividend Kings — these are companies that have managed to increase their annual dividends for at least 50 consecutive years — and dividend-focused index funds, dividends can be a reliable source of income. It is a way for companies to reward shareholders for their patience.
Part of being patient should be putting off receiving your dividend payments as cash until you retire. This is why.
Add to the Composite Effects
Most people don’t have hundreds of thousands of dollars that they can use to make a flat-rate investment, but with averaging the dollar cost, time, and patience, you can get a good amount over time. As you build your dividend portfolio, one of the best things you can do is sign up for a dividend reinvestment plan (DRIP). DRIPs take the dividends you receive and automatically use them to buy more shares of the company or fund that paid it out, adding to the total return and increasing the compounding effect. From 1960 to 2021, reinvested dividends accounted for 84% of the S&P 500the total return.
People also read…
Let’s use the Vanguard High Dividend Yield ETF, which, for example, has returned nearly 8% annually since its inception in November 2006. Taking into account the fund’s 0.06% expense ratio, this is approximately how much you would have accrued in 25 years if the dividend yield stayed at 3% and you reinvested it:
|Monthly Contributions||Annual return (including costs)||Account value after 25 years|
Even if you take dividend yields away, with a modest annual return of 8%, you can collect more than $438,000 by investing $500 per month for 25 years – while personally contributing only $150,000. However, the real magic starts when you reinvest your dividends.
Use dividends as extra income in retirement
A good strategy is to let your dividends work together until you retire and then count the dividend payments as cash. With the above account total, an annual dividend payout of 3% looks like this:
|Account Total||Annual Dividend Payment|
With those annual payouts, you could have an additional monthly income of $1,700, $3,400, and $5,100. If you follow the 80% rule — which states that you should aim for 80% of your annual income in retirement — $40,000 to $60,000 in annual dividends would be enough for someone making $50,000 to $75,000 annually.
Even if you don’t manage to get to the point where you can live off your dividends alone, they can be a great addition to other forms of retirement income, such as a 401(k), IRAs, and Social Security. It’s good to pay dividends along the way as you invest, but it’s often better to be patient and postpone your payouts until retirement. You’ll probably be glad you did.
10 Stocks We Like More Than Walmart
When our award-winning team of analysts has an investment tip, it pays to listen. The newsletter they’ve had for over ten years, Motley Fool Stock Advisorhas tripled the market.*
They just revealed what they believe to be the… ten best stocks for investors to buy now… and Walmart was not one of them! That’s right – they think these 10 stocks are even better bargains.
Stock Advisor returns from 2/14/21
Stefon Walters has no position in any of the listed stocks. The Motley Fool holds positions in and recommends Vanguard High Dividend Yield ETF. The Motley Fool has a disclosure policy.