It is a common adage that young investors should take on more risk than older investors and pursue high-growth investment strategies. There is a lot of reasoning behind this approach, but I believe it can be boiled down into three main points.
- Certain stocks have the potential for massive gains via quick increases in stock price. If you are successful at identifying these, you can get rich quickly.
- If you are unsuccessful at investing in the next “multi-bagger”, you still have plenty of time to make up for your losses.
- If you’re young and have a job that provides you with sufficient income, you don’t need to rely on the slow-growth or passive income that dividend stocks provide. Dividend income is not needed at a young age.
While I think that a portion of high-growth stocks have a place in every portfolio, I disagree with the approach that younger investors should overlook dividend investing entirely. Young investors do not need to entirely pursue growth-stocks, they don’t need to risk the potential large losses of this strategy, and I do not think that younger investors should avoid dividend paying stocks simply because they don’t need the income.
As an investor in my 20’s, my personal investing strategy is one of dividend growth investing. My strategy incorporates aspects of traditional dividend investing, value investing, and growth investing. I look for stocks of companies that pay dividends consistently, grows them consistently, appears to be undervalued (using a handful of techniques), and looks to be successful over the long term.
Through doing this, young investors can realize capital appreciation through successful use of both value and growth investing, they can have exposure to passive income through the dividend, and can build up their position over time by reinvesting the dividend overtime to compound their money.
Compounding is the key here. By reinvesting dividends, you are using that dividend to produce more dividends every time a dividend is declared. Compounding dividends is a powerful force for the long-term wealth builder, but it takes time for that power to grow and become significant. For this reason, young investors may not appreciate why dividend growth investing is such a sensible strategy for people who won’t be retiring till 40+ years from now.
Compounding is the 8Th Wonder of the World
Einstein once said, “Compound interest is the eighth wonder of the world. He who understands it, earns it… he who doesn’t… pays it.” Over time, your dividends will earn more dividends. Then your dividends that were earned by prior dividends will earn you more dividends. It seems simple, but it is surprising hard to wrap your head around just how powerful compounding is till you play some numbers and graphs. We will do that here.
Take Lowe’s (LOW) for example. For the last ten years, the stock’s average dividend yield has hovered around 2%. 10 years ago today, one share of LOW cost you $26.98. Let’s assume an initial investment of $10,000. Using Sharesight, I can back-test the performance of that investment with dividends reinvested and the result is shocking.
From June 2012 to June 2022, the stock price from $26.98 to $186.33. In 10 years, the stock price grew by almost 6x. Add to that appreciation, 10 years of growth and compounding dividends your position grew from $9,982.60 on June 11th, 2012 to $64,920.20 on June 10th, 2022.
Meanwhile, your quarterly dividend payout began at $59.20 and grew to $296 which yielded you total dividend payout of $5,960.70. With just 10 years of holding, your dividend payout grew by more than 5x and yielded you a total of $5,960.70.
The magical variable in this formula is time. In 10 short years, you can see in the graph below that the dividend payouts start to resemble an exponential curve. If I had back tested for 20 years instead of 10 years, the dividend would have grown from $4.24 to $339.20 and that curve would be more pronounced. This simply goes to show why it is a good idea for dividend growth investors to start early. The younger you are the more time you have available to you for compounding.
Comparison with Aggressive Growth Investing
The graphics above show the potential outcome of a dividend growth investing strategy played out over 10 years with only Lowe’s (LOW). Assume an investor was 55 when they started investing in LOW, held it for those 10 years, then decided they wanted to retire at 65. However, now assume that that investor was persuaded that Facebook (now Meta Platforms META) would be the next big thing and decided to invest in that instead. Instead of finishing the 10-year stint with nearly a $65,000 position in LOW that pays him over $1,000 in dividends per year, this investor now has a $55,000 position in META that pays him nothing.
Though I am picking and choosing stocks for this scenario, it clearly demonstrates that the early emphasis on dividend growth provides a greater return and a stream of cashflow to rely on in retirement.
Some of the popular growth names would have caused you to lose money over that 10-year time frame (think Achillion or Blackberry). Others produced lesser gains like Google and Apple. Others barely outperformed like Amazon and Microsoft. Only a handful really took off like Netflix and Tesla. However, are you confident that 10 years ago you could have picked Tesla while you risk accidentally picking the Blackberry? And are you confident that you could make that same decision today?
Dividend Dollars Strategy
While it’s hard to pick the next Tesla, it is not hard to pick stocks that pay consistent dividends, grow them, and have potential for future growth. As I said before, my strategy incorporates aspects of traditional dividend investing, value investing, fundamental analysis, and growth investing. I look for stocks of companies that pay dividends consistently, grows them consistently, appears to be undervalued (using a handful of techniques), and looks to be successful over the long term.
10 years ago, Lowe’s already had nearly a 50-year streak of paying and growing dividends, they had good financials, a growing P/E and a growing EPS. Fundamental analysis shows that the company has value, value that may have been overlooked in 2012 depending on what quarter you look at. From a value standpoint, 2012 had some dips in the stock price that would have made sense to buy. From a dividend standpoint, Lowe’s already had great history of payments that would make any income investor feel fuzzy inside. Overall, there was nothing fancy about them back then, and there is still nothing fancy about them today.
In conclusion, it is much easier, and much safer to take the road less traveled as a young investor. Achieving long term wealth is much more realistic when considering the compounding opportunity that already successful and healthy companies can offer you.
Young investors should not feel obligated to follow the conventional advice of pursuing high growth investing or risk day trading. Taking on excess risk with goal of achieving wild returns might not materialize. Even though they have the time to recoup those losses, they may not be able to avoid the consequences of lost time for compounding.
Here at Dividend Dollars, I am a young investor trying to avoid just that. I invest in safe dividend paying companies that long-term have the greater potential support me in retirement and may even help me retire early! I have educated myself and built a sensible long-term strategy and highly encourage you to do the same.
This website is here to help you do just that by following our posts which include weekly portfolio updates, market analysis, occasional stock due diligence articles and the shared investing resources to give you all the tools you need to start!
I am also open to conversations to help! Comment below or reach out to me on my socials if you ever need anything.