compounding returns: Building Passive Income with Dividend Growth Stocks

compounding returns: Building Passive Income with Dividend Growth Stocks

Building Passive Income with Dividend Growth Stocks

Dividend growth stocks offer a great deal of upside for long term investors. There are very few investments that can offer the type of long term, compounding growth as dividend paying stocks. Unlike non dividend paying equities, which rely solely on capital appreciation (an increase in the share price) for returns, dividend paying equities offer the potential for an increase in share price with the added benefit of passive growth of ownership stake (through DRIP investing) or passive dividend income.

Although many investors see dividend stocks as boring, there is absolutely nothing boring about the long term historical returns that can be achieved by wisely choosing a dividend stock portfolio. For more information on why we atcompounding returns favor dividend stocks, read Dividend Growth Stocks for the Long Term.

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One of the most important but rarely discussed long term benefits of dividend investing is the ability to tap the consistent stream of quarterly dividend payouts to eventually help with day to day expenses. This ability to create passive long term income is one of the greatest benefits of dividend investing. It is no surprise that dividend paying, consistent growth companies have long been known as “widow and orphan stocks”, because in the past, dividend income was often used as a source of passive income for families following the death of their primary breadwinner.

If you dream of early retirement, a source of passive income for your family, or even just an eventual source of income beyond your day job, dividend growth stocks may be one way to diversify your investment portfolio and income streams.

Step 1: Choosing a Dividend Growth Stock

You can’t build a portfolio of dividend growth stocks without doing your homework. This is particularly important since you will plan to hold each dividend growth stock for the long term, allowing the slowly and consistently increasing dividend payout to build your portfolio into a legitimate source of passive dividend income.

Some things to think about when considering a dividend growth stock include:
  • The industry’s long term prospects.
  • The company’s long term prospects.
  • The company’s economic moat.
  • The company’s susceptibility to legislation or external factors.
  • The company’s management.
  • The company’s financials.
  • Health of dividend payout.
  • Historical growth of dividend payout.
For more information on how to evaluate dividend stocks for long term growth prospects and the health of their dividend, visit Dividend Stock Investing Strategy: How to Choose the Best Dividend Stocks.

Step 2: Building Your Portfolio of Stocks

Finding just one excellent dividend growth stock isn’t enough if you are seeking a dividend income portfolio. In fact, in order to successfully use dividend growth investing to create passive income, you must find a number of solid, dividend paying companies with good long term growth prospects and a history of increasing dividend payouts over time.

So, how many stocks should you own within your dividend growth portfolio? The answer is simple. You should own as many stocks as you can actively track and manage. Purchasing shares of stock requires research. Owning stock requires additional research. Consider yourself to be what you are, an owner of a major corporation, and put in as much work and research as you believe would be appropriate.

Step 3: Building Your Net Worth with Dollar Cost Averaging

Building your net worth is easy when you dollar cost average into your stock positions. Sites like ING Direct offer a great way to dollar cost average into your investment accounts by scheduling investments on a weekly, monthly, or annual basis.

Dollar cost averaging is a great way to ensure that you continue investing despite the ups and downs of the market. Scheduling recurring transfers keeps you from attempting to time the market, and although it can result in purchasing shares in both rising and falling markets, dollar cost averaging is a widely accepted method of preventing putting all of your money into stocks at precisely the wrong time.

Dollar cost averaging into each position results in purchasing more shares when stock prices are low, and less when prices are high, dampening out some market volatility, and helping you build your net worth gradually over time.

Step 4: DRIP Your Way to Wealth with Dividend Reinvestment

Dividend Reinvestment Plans or DRIPs are one of the best techniques for small investors to build real wealth over time. DRIP plans allow you to purchase stock in a company and elect to reinvest the dividends in more shares of stock. DRIP plans offer an the amazing ability to not only compound your returns, but also to compound your dividends. Each time a dividend payout is issued, a fraction of a share of stock is added to your portfolio, resulting in a greater dividend payout during the following quarter. This continues indefinitely, and can result in huge returns. In fact, according to Dr. Jeremy Siegel in Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies, over 40% of the returns of the S&P 500 over the last 200 years have been attributed to reinvested dividends.

It is therefore extremely important to reinvest dividends regularly within a no cost DRIP investing program until you need the dividends as a source of passive income. Dividend reinvestment is a one way to turbo-charge your investment returns and make sure your passive income streams will meet your needs in the future.

Step 5: Tapping Your Passive Income for Expenses

When is the right time to tap your dividends and stop utilizing the DRIP option within your investment portfolio? Only time will tell. When life presents a situation where passive income from your investment portfolio is required, then the time is right to tap that source. Remember, that’s why you invested in dividend growth stocks in the first place.

The amazing thing about investing in dividend growth stocks for passive income is that provided enough time, your passive income from dividend growth investing can provide enough income to sustain some of your families needs without requiring you to sell any shares of stock.

If you can live off of your dividend stream alone, the price of your shares of stock will often continue to appreciate, even after you tap your stream of dividends to pay expenses. This means that your net worth will continue to increase, even while you pay yourself a salary of dividend income which increases every year as the companies in your portfolio increase their dividend payouts.

Are you a long term dividend growth investor? When do you plan to tap your stream of passive income?

For more dividend investing and passive income strategies, visit the Totally Money Blog Carnival.

About EdR

Tant que les lions n’auront pas leurs propres historiens, les histoires de chasse continueront de glorifier le chasseur. (proverbe africain)

Posted on May 2, 2011, in compounding, Dividend Growth Stocks. Bookmark the permalink. Leave a comment.

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