In the middle of the BIG crash I became very frustrated with real estate, as I watched the values of my properties evaporate. I got so frustrated that I began looking for investment opportunities outside of real estate. This search led me to dividend stocks. I read several books, blogs, and subscribed to several newsletters. I ended up creating a pretty cool compounding plan around dividends. Stock dividends are fascinating and they can be incredible compounding machines IF you have a very long-term outlook.
Here are the two main reasons why dividend stocks are fascinating:
1. You can elect to have your dividends automatically invested into additional shares of the same stock or fund. This means the number of shares you own increases with each passing year. More shares equals more dividends. This process continues to repeat itself every year and really is an incredible illustration of how compounding works.
2. Companies typically increase the amount of dividend paid each year. Dividend increases obviously can be automatically reinvested into additional shares. Higher dividends equals more shares purchased. More shares purchased leads to more dividends and this process repeats itself as time passes.
Theoretically, all you have to do is buy quality dividend stocks and elect to have the dividends reinvested. The old Ron Popeil “Set It & Forget It” plan!
Damn, he’s an awesome salesman, isn’t he?
In a nutshell, you could put this dividend stock compounding plan into motion and would haven’t to worry about it for decades. In 25 years, your compounding machine will have grown into a lot of money! The best part is this plan works regardless if the stock prices increases. The reason why is because it’s focused on compounding the number of shares owned. Any appreciation in the share price is simply a bonus.
As an example, let’s say you buy 100 shares of ATT stock today at $41 per share for a total investment of $4,100. You obviously automatically reinvest the quarterly dividend into more shares of ATT stock. If the dividend amount increases by an average of 2% a year, which it has for 30 plus years, you would have $18,405.08 in your account in 25 years. The majority of this increase came from the compounding of the dividend into additional shares of stock. More importantly, your shares of ATT stock would be paying you around $1,350 a year in dividends annually. Not too bad considering your initial investment was $4,100.
Pretty cool, huh?
There are many great blogs that go into detail on how to use this strategy. Here are a two I love:
http://www.joshuakennon.com/
http://theconservativeincomeinvestor.com/
Even though I absolutely love how dividend stocks compound, I didn’t implement the plan. The main reason why is because the plan didn’t jive with the lifestyle I wanted to live. Every compound dividend plan requires you to generate income from your labor for many years while your dividends compound. I didn’t want to work for money. I wanted my money to make money, so I didn’t have to work.
The reasons why the dividend compounding plan didn’t work for me were:
1. The amount of income provided by dividend stocks is very low. Typically in the 2-3% range annually. This level of cashflow is too low and prolongs the compounding period significantly.
2. Dividends are paid quarterly instead of monthly. It takes a lot longer to compound when you only collect four dividends a year versus twelve rent checks a year. You’re not increasing the number of shares you own at a fast enough pace and this prolongs the compounding period, too.
3. I had no control over the actual investments. I couldn’t increase the income. I couldn’t increase the value of the investment. I couldn’t increase the frequency of the dividend payments. My only option would be to simply hold the shares long-term allowing the compounding process to work its magic.
As I was studying these compounding machines, I realized how powerful real estate truly is for compounding. In most cases, it is significantly better for the exact reasons I didn’t like dividend stocks:
1. The amount of income provided by rental real estate is typically 10% or more annually. This increase in income provides for faster compounding.
2. Rent is paid monthly allowing for more frequent investment of income.
3. I have 100% control over the investment and could increase the value of the property and the income provided by the property.
So I decided to stick with real estate as the base of my compounding machine even though I had gotten my ass kicked.
My plan was to create monthly cashflow from real estate and use this cashflow to buy dividend stocks. I would obviously elect to have the dividends automatically reinvested. This way I would lock in the benefits of both compounding machines, which would allow me to compound at an accelerated pace.
However, I didn’t implement this plan either!
I began to think that dividend stocks might actually hold me back. If real estate was the better compounding machine, shouldn’t I reinvest the income from real estate back into more real estate? This would allow for even faster compounding and this is what I’ve been doing ever since.
If When the stock market crashes again, I may consider using the income from real estate to buy shares of quality dividend stocks at depressed pricing.
Until then, I’m sticking with real estate.
Note: This is one of the best parts about focusing on monthly cashflow. You can be very strategic about where you invest your income. If stocks are under valued, you can buy stocks. If bonds are undervalued, you can buy bonds. If real estate is under valued, you can buy real estate. You can focus your reinvestment of income into the best investment opportunities.
