How Investing in Compounding Dividends can Help You Retire

Written by: Seth Rogers
09/25/2019

compounding-interest

Individuals who are looking to save significant amounts of money to achieve financial independence often find the sums needed to be financially comfortable to be overwhelming beyond their grasp. One of the best places to turn to in order to get the funds needed to comfortably retire is the stock market.

It has been observed that having access to the stock market provides investors with access to the greatest form of wealth creation in human history. Investing can provide some fairly significant returns. However, some of the sums needed to get the finances ready for retirement are incredibly large and require a significant amount of returns to get there. Many people become disenfranchised when they see these significant amounts needed to retire or be independent but the idea of compounding can help to make a significant dent in the money needed. One of the best ways to benefit from compounding is with dividend stocks.

The Beauty of Compounding

Compounding returns is best displayed by the proverbial snowball rolling downhill. As it goes downhill the snowball gets larger and larger and more and more daunting. The bigger the snowball is the more it runs over and continues to grow. The funds that you invest will yield more and more money and the compounding extends.

Say you have $100, as a simple example. If you earn a 10% return on your investment than you will have $110. In year 2, if you earn an additional 10% return you will not have $120 by gaining $10 more dollars but rather $121. If you get the same return the next you, you will be at $133. Compounding expands and increases the returns as you earn dividends and interest on the dividends and interest that you have collected. This process provides an enormous snowball that, over a number of different years, your returns can expand very significantly and you can become wealthy over this period of time. 

That is the way compounding returns are, particularly with dividend paying stocks. If you are able to successfully reinvest the dividends that you are earning in other positions you will benefit from the growth and expansion of these dividends. The dividends are paid on stock purchases with the money that you collect and the money that you gain from the process increases significantly over longer period of time. Compounding returns multiple over longer periods of time where the returns become truly significant and noticeable to an investor. Compounding works even better with a concept known as dividend growth investing which can be conjoined with compounding to truly benefit an investor and provide them with access to wealth that seemed out of their far out of their reach in the past.

The Power of Dividends

A good portion of the return associated with the stock market is earned on dividends paid by companies. Generally speaking, companies that have stable earnings and a predictable business model pay larger dividends. Some of these companies will increase the dividends each year and provide individuals with an increasing stream of cash that can be used to finance your lifestyle. Dividends can be used by many in a manner similar to a paycheck; the funds can be used to cover your rent or mortgage and living expenses.

Cashing out your dividends may not be the best option. Over a period of time, dividends tend to provide significant returns if you invest them and let the earnings on your stocks compound. Over long periods of time these dividends will compound and grow significantly. When dividends are reinvested in the same companies that are paying the dividends it is known as an dividend reinvestment Plan (Drip). Most drop plans won’t charg commissions on the reinvesting of shares and it is economical to use drip plans even with small share counts. Drip plans are robotic and buy shares when the market is high and low and are a form of dollar cost averaging as a result which is a strategy that can help an investor to set their mind at ease and avoid timing the market. The Compounding on drip plans can yield enormous returns over long periods of time and can help set an investor up for retirement.

Dividend Growth Investing 

Dividend growth investing focuses on companies that have a history of increasing their dividends over a period of time. Some people will look for companies that have increased their dividends over 5 years or more while others look for those that have longer track records. Investors of dividend growth investing benefit from companies that will increase the funds that you earn from your stocks without having to invest them. Therefore, over periods of time, typically with annual or bi-annual increases, dividend growth investors reward stock holders with increasing dividends that let them grow their snowball faster.

However, some people will combine this dividend growth investing strategy with compounding and truly gain financially. By reinvesting dividends into stocks that raise their dividends every year an investor can expand their wealth significantly and allow the compounding to increase significantly in their benefit.

Be Careful The Opposite is True Too

If you have debt that you don’t regularly pay then you will start to owe interest on interest and lose financially fairly significantly. This can be a real negative and hurt you over periods of time and it is exactly why credit card debt can be so dangerous to an individual who has the debt. With credit cards, missed or late payments add to interest and fines compounding and can put you in a steep pit that is very hard to dig yourself out of. Pay credit card debt and let the compounding work for you and not against you financially.  

There is an old saying that says that those who understand interest earn it, and those that don’t pay it. Compounding is an easy concept to understand but and easy one to benefit from. Avoid having debt and use compounding to your advantage, particularly with dividends.


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