Wednesday, May 20, 2015

Front Loading Savings for a Successful Dividend Retirement

My favorite saying is that "The best time to plant a tree is 20 years ago. The second best time is today." This is why I am carefully planting each dollar seed into carefully chosen portfolio of quality dividend growth stocks available at attractive valuations. I then enjoy the increase in dividends per share from those companies, and further magnify the compounding process by reinvesting the dollars into more dividend paying companies. Thus, I am creating a positive loop, that keeps on delivering results for me.

The power of compounding is said to be one of the 8th wonders of the world. A dollar that compounds at 10%/year today turns into $1.61 in 5 years, $2.59 in 10 years and $17.45 in 30 years and $117.39 in 50 years.

This is why it is extremely important to start investing as early as possible, even if that happens during a time when you are not able to save too much due to low income. Focusing on the stream of dividend checks coming every month, quarter or year has also helped think a long-term business owner, rather than worry about meaningless stock price fluctuations.

Imagine that you started a job in 2003, and then saved 40% of your income every year. Your initial amounts invested look paltry, and the gains look pale compared to the amount you put to work. Many investors get discouraged at the initial steps, because the initial results are not visible.

Net Earnings
Portfolio Value
 $   36,000.00
 $  14,400.00
 $  21,600.00
 $         14,400.00
 $   37,080.00
 $  14,832.00
 $  22,248.00
 $         30,771.70
 $   38,192.40
 $  15,276.96
 $  22,915.44
 $         47,536.42
 $   39,338.17
 $  15,735.27
 $  23,602.90
 $         70,803.16
 $   40,518.32
 $  16,207.33
 $  24,310.99
 $         90,651.35
 $   41,733.87
 $  16,693.55
 $  25,040.32
 $         73,993.33
 $   42,985.88
 $  17,194.35
 $  25,791.53
 $      110,680.99
 $   44,275.46
 $  17,710.18
 $  26,565.28
 $      145,052.36
 $   45,603.72
 $  18,241.49
 $  27,362.23
 $      166,045.96
 $   46,971.83
 $  18,788.73
 $  28,183.10
 $      211,387.49
 $   48,380.99
 $  19,352.40
 $  29,028.59
 $      299,037.38
 $   49,832.42
 $  19,932.97
 $  29,899.45
 $      349,424.06

The table above assumes a net income of $36,000 per year after taxes, and annual raises of 3%/year. It also assumes 40% of income is invested in the S&P 500 index fund. It is easier to make the calculations using historical returns on S&P 500, as a proxy for returns on diversified stock portfolios as a whole. If the index funds are sold in 2014 and the money in is invested in dividend paying stocks however yielding 4%, they would generate $13,976 in annual dividend income.

However, after 10 years of saving as much as possible, and investing the proceeds, the power of compounding starts becoming extremely obvious. It is obvious that around that time the power of compounding starts doing the heavy lifting for your money. This is the point at which the amount of wealth and passive income starts increasing exponentially, without really much further fuel on your part (savings placed into investments). This is the point at which the invest gains start becoming noticeable and close to exceeding contributions. The knowledge gained from the first dividend investments I made, is easily applicable whether I manage a $10,000 or a $10 million portfolio. That’s why one should never despise the days of small beginnings. Even a few hundred dollars invested per month in quality securities for several years, can produce a handsome perpetual income machine.

This is essentially the reason why I have had an intense focus on saving as much as possible ever since I managed to get a decent amount of income in 2007. I decided that deferring gratification for a decade will provide much more benefits throughout my lifetime, than spending it foolishly on trophy cars, expensive vacations etc. Eight years into this experiment, I am able to see rapid increases in dividend income, net worth and ability to generate income. In a few more years, the amount of my passive dividend income will exceed my expenses. I am not saying this to brag however. I am saying this to prove that it is possible for an ordinary person to achieve financial independence if they have the ability to save a large portion of income, continuously look for ways to increase income and decrease expenses, invest money conservatively, and continuously trying to improve themselves.

I do not talk about anything else other than selecting dividend growth stocks. However, the investing part of my life is a subset of who I am. I am extremely frugal, drive a 15 year old car, and have tried to cut on big items like housing and taxes. I have also tried to earn more money at work by switching positions, getting professional certifications and expanding my education. Unfortunately, this has also resulted in increased responsibilities, and the requirement to work more than 40 hours per week.

By saving a lot however, I created a base of assets, that will produce an ever increasing stream of dividend income for decades into the future, which will pay for expenses, and ultimately go to causes and family members that deserve it. The dollars I save early in life, and invest prudently, will generate a lot of dividends and capital gains for me over my lifetime, because the power of compounding will do the heavy lifting for me. This is why investing early is important.

Relevant Articles:

Taxable versus Tax-Deferred Accounts for Dividend Investors
How to accumulate your nest egg
The importance of investing for retirement as early as possible
Let dividends do the heavy lifting for your retirement
Dividend Investing Is Not As Risky As It Is Portrayed

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