Investing secrets: Compounding dividends are the only thing that matter

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I was having dinner with a longtime friend recently and dividend stocks came up in conversation. “Why would I want to invest in dividend stocks at 3 percent, when I can invest in real estate and make a whole lot more?” he asked.

That question always make me wince.

And it makes wince for one reason: dividends generally grow. A company that pays dividends doesn’t just pay the same dividend year in and year out. They raise their dividend every single year.

Let’s take the example of Coca-Cola, which has been paying a dividend since 1987. Coke’s first dividend was less than two cents. They paid $0.0175 per share. At the time, that equaled a 2.25 percent yield. Today, Coke’s paying $0.305 per share every single quarter. That translates to a 3.15 percent yield.

Doesn’t sound impressive does it? But consider the fact that over the course of that 30 years, Coke’s dividend grew from $0.0175 to $0.305! That means their dividend went up 17 times over the course of 30 years. That’s a compound annual growth rate of 9.5 percent.

A real-world example will give us some grounding here. Let’s say that way back in 1984, you invested $1,000 in Coca-Cola. You never sold your stock and you dutifully reinvested your dividends every year. During Year 1, you would have gotten a measly $22.50 in dividends. Guess what you’d get every year in dividends by Year 30? $5,346!

That’s a yield on cost of 534.62 percent! I’m not sure of any real estate that beats that sort of return over 30 years. Keep in mind, too, we haven’t even calculated your capital appreciation. Back in 1984, your $1,000 would have bought you 341 shares of Coke. Today, Coke shares are worth $41.97, so your 341 shares would be worth $14,311.77!

So, your stock’s grown 14 times, and your dividend yield has grown 534 percent! All told, you’d have $22,440.44 in your brokerage account, plus more than $5,000 a year (and counting!) in income. It’s the magic of compounding dividends. Keep in mind that for this to work, you must find a company that’s growing decently and committed to paying and raising its dividend. A good place to start is the S&P 500 Dividend Aristocrats. These are companies that have a 25-year+ track record of raising their dividends. Most of the companies are household names: AT&T, Target, McDonald’s and Clorox.

You don’t always have to find the next Google to get rich. You just have to find a dividend grower and faithfully reinvest your dividends in a tax-sheltered account year after year. This approach will ultimately beat any real estate investment you can find.

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