Rising and falling stock prices may get a lot of attention, but dividends can play a huge role in an investor’s total returns. With Dividend Kings—companies that have been able 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 is delaying receiving the payment of your earnings in cash until retirement. Here’s why.
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Most people don’t have hundreds of thousands of dollars that they can use to invest a large amount, but with an average dollar cost, time and patience, you can get a good amount over time. While you are building your dividend portfolio, one of the best things you can do is enroll in a Dividend Reinvestment Plan (DRIP). DRIPs take the profits they receive and automatically use them to buy more shares of the company or fund that paid them, adding to the total return and increasing the compounding effect. From 1960 to 2021, reinvested dividends were responsible for 84% of Standard & Poor’s 500total returns.
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let’s use Vanguard High Dividend Yield ETFwhich has returned nearly 8% annually since its inception in November 2006, as an example. Given the fund’s expense ratio of 0.06%, here’s roughly how much you would have accumulated in 25 years if its dividend yield stayed at 3% and you reinvested it:
|Monthly subscriptions||Annual Return (fee included)||Account value after 25 years|
|500 dollars||10.94%||680 thousand dollars|
|1000 dollars||10.94%||$1.36 million|
|1500 dollars||10.94%||$2.04 million|
Even if you pull the dividend yield, with a modest 8% annual return, you can accumulate over $438,000 by investing $500 per month for 25 years – while personally contributing only $150,000. However, the real magic begins when you reinvest your earnings.
Use dividends as extra income in retirement
A great strategy is to let your earnings accumulate until you retire and then start taking dividend payments in cash. In the total calculation above, here’s what the 3% annual dividend would look like:
|Total account||Annual Dividends|
|680 thousand dollars||$20,400|
|$1.36 million||40800 dollars|
On these annual payments, you could have an additional monthly income of $1,700, $3,400, and $5,100. If you follow the 80% rule — which says you should aim for 80% of your annual income in retirement — an annual dividend of $40,000 to $60,000 would be enough for someone earning $50,000 to $75,000 annually.
Even if you can’t get to the point where you can live off your earnings on your own, they can be a great supplement to other forms of retirement income, such as 401(k), IRAs, and Social Security. Getting dividends along the way while investing is a good thing, but it’s often better to be patient and delay your payments until retirement. You’ll probably be glad you did.
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Stefon Walters has no position in any of the stocks mentioned. Motley Fool has positions in the ETF and recommends Vanguard High Dividend Yield. Motley Fool has a disclosure policy.