Dividend growth investing is a particular style of dividend investing that involves investing in companies that consistently increase their dividend distributions.
It’s an investment strategy that has many key benefits, and can suit a broad range of investors, from those starting out, to those in retirement.
Here’s a closer look at why dividend growth investing is such a powerful investment strategy.
Rising income stream
It’s no secret that dividends play an important role when it comes to building long-term wealth from the stock market.
Some studies have shown that in the long run, dividends, when reinvested, can account for up to 70%-80% of total investment returns.
So, it makes sense to focus on dividends when investing in stocks.
However, dividend growth investing takes the concept of investing for dividends one step further.
By investing in a portfolio of companies that consistently lift their dividend distributions year after year, an investor can build a dividend income stream that rises by perhaps 5% to 10% every year.
Naturally, a rising dividend income stream is superior to a static dividend income stream, as a rising dividend income stream will protect the investor against inflation.
Furthermore, a rising dividend income stream also boosts an investor’s compounding power.
Exponential compounding power
Compounding — the process of generating earnings on an asset’s previous reinvested earnings — is one of the keys to building wealth.
Over time, earning ‘interest on interest’ tends to result in the exponential growth of an investor’s capital.
And this is why dividends, in general, are so powerful. When reinvested, they enable investors to compound on a regular basis, and continually buy more shares or add to holdings.
However, in a dividend growth strategy, the power of compounding is essentially magnified.
Because the investor’s dividend income stream is increasing every year, the investor has even more compounding power.
The results, over the long term, can be astounding.
Yet, it’s not just an increasing dividend stream and enhanced compounding power that an investor benefits from with this strategy, as capital growth can also be prolific over the long run.
This is due to the fact that, over time, a rising dividend tends to place upward pressure on a company’s share price.
In other words, a stock becomes more valuable as its dividend payout increases.
As a result, investors can potentially benefit from both capital growth and a rising dividend income stream, a combination that can really propel portfolio returns exponentially higher over the long term.
Peace of mind
Lastly, it’s worth noting that companies that consistently increase their dividends are generally mature, stable companies that have a large number of institutional shareholders. When market volatility rises, these companies are often less volatile than more speculative stocks.
Knowing that you own a portfolio of high-quality companies that will continue to pay regular dividends no matter what the market is doing, provides great peace of mind when stocks are falling. As a result, sticking to your investment strategy over the long term is considerably easier.
This article is provided for general information only and is not intended to be investment advice. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.