“Never depend on a single income. Make an investment to create a second source.” —Warren Buffet. Ok so how do you create dividend income?
Most people would agree that Warren Buffet is brilliant. By building an investment portfolio, you can create an income in addition to your job. Put your money to work while you are at work. It’s basic, yet brilliant. But why stop there? Why stick to one additional income source when you could have multiple. It is possible to build an additional revenue stream within your portfolio using dividends.
What is a dividend
The online dictionary defines dividends as “a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits (or reserves).” It is a payment to shareholders in addition to market gains. By adding dividend-paying stocks to your portfolio, you can build an additional income stream. Dividends would be received by you as cash in your account or automatically reinvested into your portfolio, whichever you choose. To create the income stream, you must reinvest.
In Compounding & Coffee, we explored the power of compounding and how reinvesting earnings will ultimately generate their own earnings within the portfolio. The longer the money remains invested, the greater the power of the compounding effect.
How Do You Create Dividend Income With A Stock
The theory is the same with dividends, by reinvesting dividends you can supercharge your long-term returns because of the compounding effect. Your dividends buy more shares, which increases your dividend the next time, which allows you to buy even more shares, and so on.
Even more exciting, dividends are not paid as a percentage of share price. They are paid in a dollar-per-share style. This is exciting because when the market pulls back and the share price decreases, your dividend remains the same. Reinvesting dividends during market pull backs means that you are able to purchase even more new shares than in ‘good’ times. Ultimately your account recovery will be quicker than others because you were able to take advantage of the dividend reinvestment tool.
In April of 2020, Johnson & Johnson (JNJ) increased their dividend. If you have 100 shares as of 5/25/21 at $170.03 per share, your dividend would be $4.04 per share or $404 per year. Reinvested, this becomes more than 2 new shares to add to your position annually based on current market prices. (THIS IS NOT A RECOMMENDATION TO BUY JNJ, it’s only used to illustrate the point about dividends).
Long-Term Dividend Income Impact
Following the math for roughly five years, you’ll have increased your account balance by roughly $2020 by doing nothing. While this may not seem significant by itself, remember it is only one stock out of your whole portfolio.
You may have many dividend paying stocks in your portfolio and by managing them wisely, you can build that portion of your portfolio into its own revenue stream that is large enough to pay out your annual distribution in retirement. How great would it be if your retirement distribution came from dividends and not from the principle balance of your account.
This is on top of market earnings and while dividend payments are not guaranteed, they are expected. Dividend payments don’t follow the same market ups and downs. They are, for the most part, quite consistent and reliable. Therefore, a spectacular source of revenue in retirement. That is the brilliance of Warren Buffet, dividends and compounding. Create and nurture as many income streams as possible to fund your future. Start building early.