How to Build a Passive Income Stream That Doubles Every Decade
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The majority of questions I get asked here on The Money Sprout are about our dividend income stream.
More specifically, readers are interested in knowing the specifics of how I calculate our income growth projections.
For example, I often provide dividend income estimates for the next year by tracking our 12 month forward dividend income numbers.
The results represent what we can expect to earn in the next year if we left our portfolio alone. The income is at a point in time and takes the number of shares we currently own per stock and is multiplied by the yield of that stock.
Those totals are then added together to get our 12 month forecast.
I also like to take it even a step further and estimate how much dividend income we would be earning 5 years from now or even in a decade.
All of this forecasting is 100% passive with no additional investments into the stock market.
Building a Passive Income Stream of Dividend Stocks that Doubles
One of the coolest calculations I run is to figure out how many years it would take for our dividend income to double.
This is what makes building a passive income stream from dividend stocks fun. Watching it grow and compound and double on it’s own makes it one of the best ways to invest your money.
Of course, we are still in the portfolio building stage of our dividend income stream … so we still invest a lot of new dollars into the market. This helps to accelerate the income stream even further.
But factoring out any new money … our dividend income can grow much faster than inflation … all on its own.
This can be achieved because of two different things – dividend reinvestment and company dividend increases.
Both of these combined will allow our passive dividend income stream to double at least every decade.
Reinvested Dividend Income
The first way our dividend income can grow on it’s own is through dividend reinvestment.
For now … we choose to reinvest every single dividend we earn (down to the penny) back into more stocks. In order for our income to compound, we want to reinvest the money we are earning back into similar assets.
Sometimes we allow our stocks a chance to grow on their own by setting up a Dividend Reinvestment Plan (DRiP). So a $20 dividend payment from Apple (APPL) would be used to purchase partial shares in the same stock automatically without commissions.
Other times we let the cash balance grow from dividend income earned and buy whole shares of stock. This is our preferred method of reinvestment when using a no-fee broker like Robinhood. Plus Robinhood currently does not offer DRiP … so it makes the decision much simpler.
Either way … 100% of our dividend income is eventually reinvested.
So how much income growth can we expect annually from dividend reinvestment?
Annual Percentage Growth from Reinvested Dividends
Recently, I took a weighted dividend yield average of all the stocks, ETF’s, and index funds found in our portfolio.
Note – This yield is the dividend percentage an investor would earn on their investment based on the current share price.
The weighted dividend yield for our portfolio currently is 2.97%.
This means for every $1,000 in dividends that we earn and are reinvested … we can expect to turn that into $29.70 of future dividend income.
Dividend Growth from Reinvestment = 2.97%
One other item to point out … that 2.97% yield would be the same average dividend return on stocks purchased with new investment dollars too.
And by the way … the 2.97% average yield for a stock isn’t all that surprising. One of our stock screening criteria for buying a new stock is to look for companies with a current yield >= 2.5%.
So our average isn’t too far off!
Dividend Growth Rate
The second way our dividend income can grow on it’s own is from annual dividend increases.
This is commonly referred to as the Dividend Growth Rate (DGR) of a company and is often measured in increments of – 1 year, 5 years, and 10 years.
Before purchasing a stock, we use the 5 & 10 year dividend growth rates as a filter when screening a company.
Normally, we look for companies with a 5 year DGR of 6.0% or higher. And sometimes we even go out 10 years and screen for companies with a history of 6% or higher dividend growth average for the past decade.
So in theory, there is a good chance our dividend income will grow annually on it’s own by another 6%.
This assumes the stocks we invest in are from quality company’s that in fact continue to raise dividends by an average of 6% per year.
Calculating Our Annual Dividend Growth Rate
In order to calculate the expected dividend growth rate of our overall portfolio … I once again took the weighted average.
I weighted each stock in our portfolio by the current dividend income it generates. To get the current dividend income, we simply multiply the number of shares we own times the current yield.
So if our Target shares (TGT) accounted for $100 out of a total of $1,000 in annual dividend income … it’s weight would be 10%.
Pretty simple stuff.
The next step is to find the most recent dividend increase (or decrease) and multiply it by the weighted average for each stock. This will give us the annual dividend growth rate across our entire portfolio.
One thing I should point out … I used the most recent increase within the past 12 months to get a current snapshot. I think this gets us close enough on a “back of the envelope” type of calculation.
Based on these rules, I estimate that (at the time of this writing) our dividend income is growing on average by 6.19% annually from dividend increases alone.
Dividend Growth from Company Increases = 6.19%
Again … not so surprising given that we screen for stocks with a 6% or higher DGR.
A Few Assumptions on Calculating Our DGR
Anytime I do calculations like these … I always want to figure on the conservative side.
Based on this, I had to make a few conservative assumptions when calculating our annual DGR.
- Out of 38 stocks we own, CVS Health Corp (CVS) is the only stock that hasn’t raised it’s dividend in the past 12 months. Even though this stock currently accounts for 4% of our dividend income, the weighted average is 0% because of the 1 year growth rates.
- About 0.5% of our dividend income we earn comes from Unilever (UL) which is not a US company. Based on it’s erratic dividend growth behavior compared to other dividend stocks … we have weighted this average at 0%.
- Over 22% of our dividend income comes from the following – Vanguard Total Stock Market ETF (VTI), Fidelity Total Market Index Fund (FSKAX), and Fidelity U.S. Bond Index (FXNAX). It’s almost impossible to track the dividend growth rates of these and therefore each is weighted at 0%. This seriously keeps our estimates on the conservative side.
- Norfolk Southern Co. (NSC) raised their dividends twice this year (2018) for a combined 29%! Since this doesn’t seem sustainable on a yearly comparison, we simply used the latest increase of 11.1% in our weighted average.
- For our shares of Realty Income Corp (O) that pays a monthly dividend we used a different method for calculating dividend growth. We simply used the dividend income that will be earned in 2018 versus what was earned in 2017, since the REIT will increase their dividends multiple times per year.
The assumptions we made above when figuring out our annual dividend growth rate are very conservative. This gives us a lot of confidence that our DGR is actually closer to 6.5% instead of 6%.
So we are very comfortable using the 6.19% annual return in our future dividend income calculations.
How Much Can Our Dividend Income Grow by Itself Each Year?
For the past year, I have been including our future income estimates in our monthly dividend stock reports.
I generally include our 12-month future income totals … which is the estimated dividend income we’d earn starting today for the next year. This is without any new invested dollars.
The income is strictly based on the number of shares we currently own times the current dividend. This assumes a company will not cut or lower their dividend and at a minimum maintain it.
As each month passes … two different things happen to allow this 12-month dividend income figure to grow. These are the dividend reinvestment and company dividend increases we highlighted earlier.
Calculating Our Total Annual Dividend Growth
The final step in calculating our total annual dividend growth rate is to simply add the two different calculations together.
So we know that on average, we can expect a 2.97% yield on any dividend income that is reinvested. So if we earn $5,000 this year in dividend income … it would generate an additional $148.50 of new income next year.
And we also know that on average, we can expect a 6.19% annual increase from companies that we already own. So that same $5,000 of dividend income this year … it would grow an additional $309.50 of new income next year.
Combined we have an additional $458 of dividend income generated next year on our $5,000 income stream today. That is without any new investments made or work on our part.
That is the equivalent of a 9.16% dividend growth rate!
Total Passive Dividend Growth Rate = 9.16%
So what does this number mean? I’d say it is a pretty darn good return on our investment.
It is also a number we commonly use to determine how quickly our dividend income stream can double … without any work from us. We use the Rule of 72 in order to calculate the time it will take for our income to double.
The Rule of 72
Another figure I provide in our monthly dividend income updates is the Rule of 72 projection.
The Rule of 72 is a shortcut calculation that can be used to estimate the number of years required to double your money at a given annual rate of return.
The calculation is actually very simple. You divide the rate of return by 72 to get the number of years.
# of years to double investment = 72 / annual rate of return
In our case, we use the rule to see how fast our dividend income will double.
So taking our DGR of 9.16%, we can project our dividend income would double every 7.86 years.
# of years = 72 / 9.16% = 7.86
Now if you follow my monthly reports, I always show our dividend income doubling every 9 years (not 7.86). Again, this is me just be overly conservative on our estimates.
So instead of using 9.16% return, I use a conservative 8% instead. That means our dividend income should double every 9 years (72 / 8) at the very minimum.
Anything else is even better but I can sleep at night knowing our dividend income will double every 8 to 9 years!
Building a Passive Income Stream from Dividend Stocks
If we were to stop investing any new money today, I would still feel confident our dividend income stream would continue to grow on it’s own.
And in fact, I would feel very confident it could grow faster than inflation.
There isn’t much better feeling when it comes to building side income than knowing it can and will grow every year all on it’s own.
Let me leave you with one last example –
We expect to earn $7,400 in dividend income for 2019. This is income that is expected between January and December without any new investments.
Knowing that this income stream can grow all on it’s own by 8% to 9% annually … we can expect it to grow to $14,800 by 2028.
And by 2037 … this income stream will have exploded to almost $30,000 of passive income!
All of this work done without a single new dollar invested in the stock market.
Have you calculated your total dividend growth rate of your income portfolio? What assumptions do you make when running your calculations?