Compounding of dividend stocks

Previously I had discussed creating a dividend stock profile of blue-chip stocks to generate a passive income stream. Now I would like to talk about why starting early on and just putting aside a small amount each pay cheque, will lead to immense savings down the line. This is because of compounding.

The S&P500 grows at about 10% each year over the long run. Let’s just be a bit conservative, and say that our dividend profile will give a return of about 7% a year till we’re 65 and ready to retire. So if you invest $200 every two weeks, starting from when you’re 25, and you retire at 65, you will have $1,145,880.92 by the time you retire (see figure below). With that money in a savings account when you’re retired, at an interest rate of 1%, it’ll provide you an income of $52,030.73 per annum. Although I’d personally keep the money invested in the dividend stocks, at least a substantial portion of it. For me, I use a stock broker in Canada where it is FREE to purchase ETFs (Questrade). If trading with your stock broker can result in some fees, you’ll have to think about less frequent trading (maybe $400/month or $800/2 months, something along those lines).

retirement fund

Growth from investing just $200 bi-weekly over 40 years (light blue)

There are ways to even better your returns. By using a DRIP (dividend reinvestment plan), you can have your dividend payouts be automatically reinvested and have additional shares purchased, without having to pay brokerage fees! Many blue chip stocks will support DRIPs. As you can see, the earlier you start, the bigger the effect of compounding.

Another very important factor is dollar cost averaging. Now some of you might wonder what happens when the stock market undergoes a correction or crashes. This is where dollar cost averaging comes into play. When you’re investing constantly according to a fixed plan (e.g. $200 bi-weekly), then you’ll be buying the dips when the stock market undergoes a correction. As the stock market always recovers, dollar cost averaging will kick in, and allow for huge gains from the shares you bought at a low price. So the most important thing is to not panic sell, and to stick to your plan of investing!

Start saving and putting aside a bit now, and you’ll be surprised at how much you’ll end up with!

The Intelligent Investor: The Definitive Book on Value Investing. A Book of Practical Counsel (Revised Edition) (Collins Business Essentials)

Disclaimer: This post is my own personal opinion. I am not a professional financial adviser and am not responsible for your own investment outcomes. 

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