The majority of the people in this country aren’t savers. They don’t think about how to prepare themselves for retirement, especially not at an early age. They don’t realize that you don’t become wealthy by earning a salary. Instead, you become wealthy by saving and investing or building something on your own. Saving and investing is a long-term process that takes a lot of time and commitment. However, if you put in that time and commitment, you can maximize your chances of becoming wealthy. Although there are many different types of assets you can put your money in, each with their pros and cons, investing in dividend stocks is one tried and true way of generating long-term wealth and passive income.
When I first discovered the early retirement and financially independent community online, I was blown away and fascinated. I never imagined that there were so many people who could achieve financial freedom at such a young age without needing to win the lottery or inherit a substantial sum. I was hooked and needed to learn as much as possible.
What is a Dividend Stock?
A dividend stock is simply a stock that pays out a dividend on a regular basis. A dividend is simply a cash payment. A lot of the large, stable, and successful companies will issue a dividend to reward their investors. Unlike growth companies, large, dividend paying companies choose to use their earnings to pay the investor. These companies probably don’t have much more room to grow. As a result, the successful cash generating ones will reward their investors with checks instead. On the other hand, growth companies will reinvest their earnings back into their business and bet on growth of the company itself rather than generating more cash for the investor.
Why Dividend Stocks?
Look for strong dividend stocks that have the ability to consistently reward their investors with increasing dividends. If a company has a strong track record of consistently paying their investors while increasing their dividends, it signals (but doesn’t guarantee) that the company is well-run and generates cash. Their management must be doing something right if they can maintain that record.
Dividend stocks also tend to be more stable. In recessionary times, the stability of a large dividend stock can bring you security and consistent income.
Power of Growing Dividends
Let me show you an example to demonstrate the power of dividends. Caterpillar (CAT) is a large company that has consistently paid out and increased their dividends for years. If you put about $50,000 into CAT in 2001 and held onto it until the end of 2015, your portfolio value would have grown to $180,298. In addition, you would have collected $68,978 of dividends that you could have reinvested back into the stock.
So those returns aren’t necessarily special. What I do think is special is the fact that your effective annual dividend yield would be 16% or $7,800 a year generated from your initial $50,000 investment. That means, as long as CAT maintains their dividends (which they most likely will based on their track record), you are pretty much guaranteed a 16% annual return on your initial investment of $50,000. Regardless of whether the stock goes up or down, you’ll still receive that amount at the minimum. Even if the entire market is tanking, you’ll still receive that dividend. How many investments out there will almost guarantee you 16% or greater every single year from this year onwards?
Yes, that income took fifteen years to develop. However, keep in mind that you should invest for the long-term. During those fifteen years, you’ll be collecting income and seeing your stock grow in value most of the time. With this simple strategy, you can be yielding extraordinary amounts from your stocks.
Note: The above calculations do not include the effect of taxes, which would lower your rate of return. However, my general point remains the same. In addition, most forms of income you collect will be taxed anyway.
Ride Out Price Fluctuations
Since strong dividend companies tend to either maintain or increase their dividend payouts every year, you don’t have to be too concerned with price fluctuations. If prices go down, you still get the same dividends. In fact, decreasing prices provides an opportunity for you to buy since you will be able to buy the same dividend income at lower prices. If prices go up, you get the same dividends along with increasing asset values.
With growth stocks, you don’t get the benefit of increasing dividends. So, if your growth stock drops in price, you won’t get anything out of it.
If you’re unsure of what dividend stocks to invest in, you may want to consider a dividend exchange-traded fund (ETF). With an ETF, you’ll automatically diversify yourself among a variety of dividend stocks. Just make sure you buy one that has low fees.
Passive income is income that requires no work on your part (the best kind of income). Dividend income is a form of passive income. You just get paid for owning the stock. It can be used to cover some of your current expenses or to fund your retirement. Payments are consistent and anticipated. You can predict how much dividend income you’ll receive each quarter, so you can use them to pay off your bills. Once you've invested in enough dividend stocks, the dividend payments from those stocks can fund your retirement. Imagine being able to do whatever you want, whenever you want, and not have to report to a manager or deal with clients. That is what passive income can allow you to do!
Not only will you get the benefits of dividends, you’ll get the benefits of price appreciation. Although one downside of dividend stocks is that they won’t grow as much or as quickly as growth stocks on average, you can always reinvest those dividends back into your stock to increase your ownership stake. As a result, you’ll grow your wealth and dividends at the same time. You’ll create a snowball effect where both your wealth and income are increased every year as long as you consistently invest and reinvest your money back into the stock.
To start learning about stocks, I recommend you check out my top online resources for stock investing. If you want to get a better understanding of the math behind early retirement, I ran some scenarios as well.
There’s a large community of people looking to achieve financial independence at an early age. If you are interested, check out these additional sites for more information:
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