The Dividend Snowball Effect: Maximizing Growth

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Have you heard of Quincy, Florida? Well, that town became famous for being the single richest town in America, with 67 millionaires back during the Great Depression. Now, how did this happen? Did they strike oil in Florida? Well, the town banker named Mark Welsh in the 1920s and 30s encouraged his clients, friends, and family to invest in Coca-Cola stock. Now, he noticed how people would scrape together their last nickel to buy the soft drink and believed in its staying power. Now, the dividends from that stock helped the town survive and thrive through the Great Depression and every recession since. But just how important are dividends to an investment portfolio? And why can they be valuable? Hi, I’m Ken Hargreaves, president of WealthGen Advisors. And today, I’m excited to share with you how the dividend snowball effect works and what other impacts a dividend portfolio can have on your wealth.

So, how does the dividend snowball effect work? Well, when you invest in a stock that pays a dividend, if you automatically reinvest that dividend into that stock, it starts to grow the number of shares you own. Quarter after quarter, dividend after dividend, the number of shares you own begins to climb. Now, in a $10,000 investment that has a 3% dividend, you’re reinvesting $300, and that’s just the first year, because in year two, 3% of $10,300 is $309. In year three, it’s $318. So let’s look at how dividends can impact your portfolio over long periods of time. Consider a portfolio of $10,000 that grows by 4% per year. Now, that’s just slightly above normal inflation. Over 35 years, that portfolio grows from $10,000 to $38,000.

Not too bad, but not too great. Now consider the same exact portfolio that has a 3% dividend reinvested each year with that same 4% gross return. Well, the value at the end of that 35 years is over $107,000 and if you held it just five years longer, it’s now worth over $147,000. In this scenario, the dividend contributed 74% of the total return. Now consider this, since the 1940s, dividends have contributed over a third of the total return in the stock market. But that’s not all. You see, it varies drastically by decade. In the 1940s and the 1970s, dividends contributed around 70% to the S&P 500’s total return, which is similar to our example. Now that 1980s and 1990s, it was below 30%. So why the fluctuation?

Well, because in the 40s and 70s, they saw returns that were fairly low compared to those in the 80s and 90s. Also, companies change their emphasis on dividends during periods of growth or economic stress. In periods of super high stock growth, dividends have a little bit lower impact in total return. But in periods of high volatility and lower stock growth, expect a higher contribution from your dividend. Now, that’s not all the benefits dividends have in a portfolio. Research shows that dividend stocks can also help push in your portfolio during market downturns. As John Burr Williams, a legendary dividend economist, puts it, a cow for her milk, a hen for her eggs, a stock, by heck, for her dividends. As always, consult your certified financial planner or advisor to understand how dividends can appropriately fit into your portfolio. Thanks for watching and please feel free to comment.

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