How to Harness the Dividend Snowball

We had a great live event last Wednesday with viewers on both Zoom and YouTube.

The theme was how to shape your portfolio to achieve your investing goals. I walked through the math you could use to start paying your bills with your dividends. And how to use those equations to calculate the amount of money you would need for retirement.

I also offered a simpler method. If you want to skip the math and just get started, I had a chart with percentage weightings for a balanced dividend portfolio. It’s 50% Bedrock Income and 50% Current Yield, and I broke it down even more specifically for each group.

If you missed it, a live recording is available here.

Whether you use one of these methods or one of your own, I want to stress one important part of the plan:

Any dividend income not used to pay expenses should be reinvested.

There are exceptions, of course. Speculations or stocks you plan to hold for less than a year are two examples. But to really get the most horsepower out of your money, income from long-term holdings that isn’t needed today should be reinvested to reap the magic of compounding.

Choose Your Destiny

It’s said that Albert Einstein called compound interest the eighth wonder of the world. He also said, “He who understands it, earns it, he who doesn’t, pays it.”

Unless you’ve paid cash for every purchase your whole life, you’ve probably paid some amount of interest. And if you don’t carefully manage revolving credit balances, the interest can really start to snowball out of control. That’s because you end up being charged interest on the interest.

Here’s where you can flip the script.

Most brokers make it easy to reinvest your dividends. It’s usually as simple as clicking a box when you open the trade, or in the dividend reinvestment or DRIP section. In a Schwab account, just select “Yes” in the “Reinvest” column.

Instead of your dividends being deposited into your account, your broker will automatically buy more shares with them. Then, the next dividend will be paid on your initial investment, plus the fractional shares bought with your reinvested dividends. Yep! You will get dividends on your dividends. Over the life of your investments it will supercharge your wealth building power.

Even a Few Years Make a Difference

Compounding really starts to accelerate somewhere between years 7-12. The longer you hold the investment, the more obvious the effects become.

My usual dividend reinvesting example is a chart of McDonald’s (MCD) that starts in 1990. It shows the drastic difference that compounding achieves after a few decades. Today, I decided to pluck a position out of the Yield Shark portfolio—Philip Morris (PM).

The entry date for PM was October 26, 2021, almost exactly four years ago. So, how much of a difference was there between reinvesting the dividends or keeping them as income? Is four years enough time to notice?

You can start to see the lines deviate in just one year!

A $5,000 initial purchase would have been 51 shares at $96.80 for a total of $4,936.80. With reinvested dividends, you’d currently have 61.91 shares worth $9,485.83.

If you had taken your dividends as cash, you’d still have 51 shares worth $7,813.71. Add four years of spent dividend income worth $1,065.90, and your investment would have returned $8,879.61.

That’s a difference of $606.22—or an extra 12% return—in just four years. And that’s just the beginning.

The trade-off is forfeiting four years of regular quarterly income. If your goal is to pay your bills with dividends, then take them as cash. There’s nothing wrong with that. Your investments should meet your individual goals. But if you don’t need the income right now, reinvest those dividends. Don’t leave that extra money on the table.

Kelly Green

P.S. If YouTube videos are more your style, I turn these weekly articles into short videos. As always, please reach out to me with questions you want me to answer here in my weekly missive or in a video.