Hello! Dividend investing is a very interesting topic. Today, I have an expert who has appeared on Forbes, Motley Fool, MSN Money, TheStreet, and more, and he is going to share tons of great information on this subject. You may remember him from his previous contribution How I Became A Successful Dividend Growth Investor. This is a guest contribution by Ben Reynolds.  Ben is the CEO of Sure Dividend.  Sure Dividend helps people build high quality dividend growth portfolios for the long run.

Early retirement is the financial state of being where you don’t have to work.  You only work if you want to.

Early retirement is reached when your passive income exceeds your expenses.  The average retirement age in the United States is 63.

Retiring at any age is an accomplishment, but I think you will agree with me when I say that the earlier you retire, the better.

There are 6 key factors that determine how long it will take for you to reach retirement:

1. Your income (how much money you make)
2. Your savings rate (the percentage of your income you save)
3. Your expenses (how much money you spend)
4. The size of your investment account (how much you already have saved)
5. Your investment returns (how fast your investments are growing)
6. The yield on your investment portfolio (how much your investments pay you)

Making Sense of Cents has phenomenal information on increasing your income and savings rate, and reducing your expenses.  These are all vital aspects of retiring early.

The size of your investment account now is based on your past decisions and for some people, being born into a wealthy family.  It is what it is; you can’t change it.

How you invest will determine your investment returns and the yield on your investment portfolio when you are (early) retired.

I believe that dividend growth investing is uniquely situated to offer individual investors a way to build a portfolio for rising passive income that will lead to early retirement (depending of course on your income and expenses).

 

What Is Dividend Growth Investing

Dividend growth investing is what it sounds like.  The core idea of dividend growth investing is to invest in businesses via the stock market that are likely to pay growing dividends over time.

As an example, Johnson & Johnson’s (JNJ) dividend history over the last 20 years is shown below:

Source:  Johnson & Johnson Investor Relations page
Note:  The 2017 number shows dividend payments to date.  It will be higher than 2016 by the end of the year.

As you can see, Johnson & Johnson shareholders have seen their dividend income grow from $0.43 a share in 1997 to $3.15 a share in 2016.  This is a 7.3x increase.  More importantly, that 7.3x increase in income came without buying additional shares.

Dividend growth investing has a hidden benefit.  It focuses you on the business, and not on the stock price.  This means less (and hopefully no) panic selling during recessions.  In fact, many dividend investors take advantage of market declines by purchasing into great dividend growth stocks while they are trading at a discount.

The reason dividend growth investing matches up with building an early retirement portfolio so well is because it provides rising income over time.  This is a powerful feature that is not a characteristic of investing in bonds, gold, Bitcoin, or stocks that don’t pay dividends.

 

Reinvesting Dividends and Early Retirement

A portfolio that creates rising income over time is powerful.  You can ‘super charge’ growth by reinvesting dividends back into the portfolio.

When Johnson & Johnson pays its dividend, instead of taking it in cash, you can use that dividend to buy more shares of Johnson & Johnson.  You can see how this can greatly increase your passive income stream in the future in the example below.

Johnson & Johnson currently has a dividend yield of 2.6%.  The company has grown its dividend at 11% a year from 1997 through 2016.  Forecasting 11% a year growth ahead may lead to disappointment; there’s no guarantee Johnson & Johnson will continue such strong growth. 

Say the company grows its dividend at ‘just’ 7% a year going forward.  If you are reinvesting dividends, your income stream from Johnson and Johnson will grow at 9.6% a year.  Your income growth is simply the expected dividend per share growth rate plus the company’s current dividend yield (if dividends are reinvested).

With 9.6% a year compounding, your income from Johnson & Johnson will double about every 8 years.  I don’t know many other situations outside of dividend growth investing where you have a high likelihood of doubling your income in under a decade.

Strong income growth over time is why dividend growth investing can help you achieve early retirement.  It isn’t instantaneous, but it is achievable.

 

Where to Find Great Dividend Growth Stocks

Johnson & Johnson is a strong dividend growth stock…  But it’s not the only one.  There are other great businesses with long histories of increasing their dividend income every year.

My favorite place to find potential dividend growth stocks worthy of an early retirement portfolio is the Dividend Aristocrats Index. 

The Dividend Aristocrats are a group of 51 stocks in the S&P 500 with 25+ consecutive years of dividend increases.  A few examples of well-known Dividend Aristocrats are below:

• Aflac (AFL)
• 3M (MMM)
• Coca-Cola (KO)
• Wal-Mart (WMT)
• Exxon Mobil (XOM)
• Procter & Gamble (PG)
• Johnson & Johnson (JNJ)

The Dividend Aristocrats index is made up of businesses with long histories of rising dividends.  A company simply cannot pay rising dividends for 25+ consecutive years without a strong and durable competitive advantage.

Why do competitive advantages matter? Warren Buffett himself says they are the key to investing.

“The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage.” – Warren Buffett

Not surprisingly, the Dividend Aristocrats Index has outperformed the S&P 500 over the last decade by 2.8 percentage points a year…  With lower volatility.

Source:  S&P Fact Sheet

To put this into perspective, $1.00 invested in the Dividend Aristocrats index 10 years ago would be worth $2.59 now, versus $2.00 for the S&P 500 (both numbers include dividends).  Moreover, your portfolio wouldn’t have had as severe price swings, because the Dividend Aristocrats index has lower volatility than the S&P 500.

 

Final Thoughts

There’s no question building a portfolio for early retirement can be complicated…  But it doesn’t have to be.

By investing in individual great businesses and holding them for their rising income potential (dividend growth investing), you can build a portfolio that is very likely to pay you rising income over time. 

And importantly, investing in individual stocks eliminates costly management fees from mutual funds and ETFs so your money is left to compound in your account, where it belongs.

The bottom line is that retirement requires a stream of income in excess of your expenses.  That income stream must also grow at least as fast (though preferably much faster) than inflation.  Otherwise, you lose purchasing power – and you won’t stay retired for long.

Dividend growth investing can create growing income streams that are likely to rise well in excess of inflation.  The unique characteristics of dividend growth investing are a compelling match for those seeking early retirement.

Are you interested in dividend investing? Why or why not?

The post Reaching Early Retirement Through Dividend Growth Investing appeared first on Making Sense Of Cents.

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