Many people dream of one day being able to live off the dividends from their portfolio. But how to get to this point is a completely different question, and we want to explore this today.
If you want to live off dividends without constantly having to sell shares, it seems logical at first to choose the shares with the highest payouts. If I want to collect €10,000 per year in dividends, i.e. around €700 net per month, I need around €1 million with a dividend yield of 1%. If, on the other hand, my shares pay out 5%, the amount is reduced to €200,000, which seems much more realistic for most people. The trick is that you don't need dividends at the start of the savings phase and most companies increase their dividends over time. The challenge is not to maximize the dividend today, but in 20 or 30 years with the capital invested today. What is the return if company X increases the dividend by y % every year? The first question is: How much do the companies pay and by how much do the dividends increase? For the US market, the relationship is as follows:
On average, the dividend is 1.8% and increases by around 8% annually. The decline in dividend growth with higher dividend yields is clearly visible. This is also in the nature of things, as dividends have to be generated first. High-growth companies only pay out a small portion of their profits because they use a large portion for further growth, which also enables higher dividend growth. As these companies are generally also valued higher, the proportion of the share price accounted for by the distribution tends to be lower. Conversely, shares with high dividend yields usually have low growth and high payout ratios as well as a lower valuation. The scope for further increases is therefore smaller. You will hardly find a share that pays out more than 8 % on average and increases its dividend by more than 20 % every year.
To make things a little more interesting, let's look at 5 stocks that have varying dividend yields and growth, over a long period of time.
Visa: 0.6% Yield/18% Growth
Nike: 1.2% Yield/11% Growth
Paychex: 2.6% Yield/9% Growth
Intel: 4.2% Yield/6% Growth
Verizon: 7.8% Yield/2% Growth
Now we can pretend that we invest €100 once and see how much dividend we receive each year over time. Over a 30-year period, the stock with the lowest initial dividend yield wins out over all others due to its high growth. Even with the sum of all dividends paid over time, Visa comes out on top. Exponential growth in perfection, Leonhard Euler likes that. So far so good, and that's how it was shown on many a social media channel.
But the crucial thing is that most people don't need their dividends during the savings phase and reinvest them instead. If you do this in our model calculation, the picture changes dramatically and Verizon is still ahead after 30 years. This also seems logical, as the reinvested capital also yields very high dividends, which offers an enormous advantage over Visa's exponential growth, especially at the beginning, and compensates for the low growth. Reinvestment increases the effective dividend increase from 2% to a full 10%. Visa also has this effect, but it is much less pronounced and it is much more difficult to catch up.
What can we learn from these considerations? Consistency beats growth and growth beats returns only at first glance:
The most important thing is consistency. Only if a stock pays dividends over a long period of time and grows at the same rate can we estimate where it is headed. Out of several thousand listed companies in the USA, only 125 have been able to increase their dividends over a period of more than 25 years. Over 50 years, there are not even 50.
The lower the dividend growth, the more important it is to reinvest the distributions - especially if the dividend yield is high. This multiplies the effective dividend growth enormously.
In the long term, high dividend growth beats a high dividend yield only without reinvestment.
What we have completely ignored here is the following: The total return is made up of price gains and dividends. In our example, we only looked at dividend growth. If you look at the total return of Visa and Verizon, there is no doubt who the winner is. The dividend calculation only works as long as you hold the shares and don't sell them. So what can you do? As with everything, it depends on the right mix. For example, it can make sense to have a proportion of high-dividend stocks in your portfolio to increase your own cash flow and thus buy more shares in other companies.
Conclusion: When building wealth, it is not just the amount of the dividend that matters. Continuous payments and steady dividend growth are much more important in the long term - especially in times of crisis.
Did you already know? 50% of our supplementary dividend share portfolio consists of aristocrats, i.e. shares that have continuously increased their dividends for more than 25 years. Have a look!