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What if I told you it was possible to double your income every 9 to 10 years?
It’s true … by letting your investments (or in this case income) compound overtime, it is possible to double your return in less than a decade. How in the world is this possible?
It is simply the power of compounding your earnings … or in this case your income.
As an income investor, I frequently like to project our future dividends. It helps me determine how much dividend income we will likely be earning in 10 to 20 years.
One of the scenarios I like to consider is how long it will take for our dividend income to double … without any new investments.
How to Double Your Dividend Income
At the end of this year (2017), our portfolio of stocks should generate $2,500 in dividend income. Our dividend income has really started to grow over the past 3 or 4 years.
Just 3 short years ago, we didn’t even earn $1,000 for the year (2014) in dividends.
The majority of our recent dividend income growth has come from new investments. For example, over the last 4 years, we have invested about $45,000 of new money into dividend paying stocks. If those investments had an average yield of 3.0% … that is an extra $1,350 of annual income we have created.
All of that growth is great … but it has one little problem. It took $45,000 of our after-tax income (from my job) to create that $1,350 worth of dividend income.
There is some good news to all of this though. You see, one of the great things about building a portfolio of dividend stocks is the compounding effect that happens overtime. Some refer to this as the “Snowball Effect”.
As each quarter and year passes, the companies that we own in our portfolio are raising dividends annually. This is what allows our portfolio (along with dividend reinvestment) to grow on it’s own each and every year.
I mentioned earlier that one of the calculations I like to know is how long will it take for our dividend income to double? We like to use the Rule of 72 for a quick back of the envelope calculation to get the length of time.
What is the Rule of 72?
At a very high level, 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.
years required to double investment = 72 ÷ annual rate of return
Since this calculation uses compounding interest, we won’t get into the guts of it. Just know that it is an estimate and it works well for annual interest rates between 6% and 10%.
Here are a few good places to find more information about the Rule of 72 –
- What is the Rule of 72? – by Investopedia
- The Rule of 72 – by Dividend Growth Investor
- Rule of 72 – on Wikipedia
This calculation works great for your investments … and even for dividend income growth.
Our Dividend Income Should Double Every 12 Years
Using the Rule of 72, I have been able to calculate how long it would take our dividend income to double … assuming we never invested another new dollar.
As we have learned already, all we need is the compound annual interest rate to calculate the number of years until our income doubles.
The good news is that I recently calculated how much our dividend income “should” grow annually just from company dividend increases. Based on a weighted average of stocks we own in our portfolio, I have estimated our dividend income will grow by 6.12% over the next 12 months.
Using the Rule of 72 calculation, I can get a back of the envelope estimate of how long it will take for our dividend income to double.
For the ease of this calculation, I will round the dividend growth rate to 6%.
years required to double dividend income = 72 ÷ 6
12 Years to Double Dividend Income
If my wife and I stopped all new investments into our dividend income portfolio, and suspended all dividend reinvestment’s … our dividend income would take approximately 12 years to double.
Don’t believe the calculation? Check out the annual dividend income results below based on a 6% annual increase. We will assume that this year we will earn $2,500 in dividends … which will be referred to as “Year 0”.
- Year 0 – $2,500
- Year 1 – $2,650
- Year 2 – $2,809
- Year 3 – $2,978
- Year 4 – $3,156
- Year 5 – $3,346
- Year 6 – $3,546
- Year 7 – $3,759
- Year 8 – $3,985
- Year 9 – $4,224
- Year 10 – $4,477
- Year 11 – $4,745
- Year 12 – $5,030
So as you can clearly see from the results above, during year 12 we have doubled our dividend income.
The really cool thing is that we can expand this out and see how our dividend income could double every 12 years –
- Year 12 – $5,000
- Year 24 – $10,000
- Year 36 – $20,000
- Year 48 – $40,000
Now I am not going to try and wait around for another 48 years to start earning $40,000 in dividend income … that just isn’t practical. But it is a neat way to show how compounding income can grow.
Our Dividend Income Will Likely Double Every 9 Years
In our previous example, I used a very conservative growth rate of 6% to show our dividend income compounding. This assumes that none of our dividends earned would be reinvested. That just isn’t going to happen as we are building our portfolio. We won’t need to use these funds to pay our bills right now, so it makes sense to reinvest them.
Taking a conservative estimate, let’s assume that we will earn a 2% yield on our reinvestment’s each year. Adding in the 6% annual dividend increases from company’s we own … and we could conservatively assume at least an 8% increase.
So our Rule of 72 calculation would now look like this –
years required to double dividend income = 72 ÷ 8
9 Years to Double Dividend Income.
I like 9 years better than 12! This is what our dividend income doubling could look like assuming an 8% compounding growth rate –
- Year 9 – $5,000
- Year 18 – $10,000
- Year 27 – $20,000
- Year 36 – $40,000
So compared to our 6% return, we have essentially knocked off 12 years of compounding to reach $40,000 in dividend income. Pretty cool!
Investing More Income at an Early Age
There are a lot of different ways to “play” with this calculation. It can help you decide if your future dividend income fits with your goals for financial independence.
What you will find is that the more dividend income you can build up at an early age … the better. This is no surprise and why many experts tell you to invest as early in life as possible. Dividend investing is no different.
The other important factor is the compounded annual rate you can get. This is one big reason why I stopped chasing high dividend yielding stocks years ago.
Most of the time, stocks with high current yields have low growth rates. While stocks with lower current yields have higher long term growth rates.
That higher growth (around 6% in my case) is very important.
Finally, you can clearly see the impact that reinvesting those dividends has. We knocked off 12 whole years in our scenario above to earn $40,000 per year in dividends … just by reinvesting our dividend income each year.
One item that could exponentially increase your dividend income even further is to continue adding new capital each year to accelerate your growth. And that is what we are doing.
Do you use the Rule of 72 or any other similar calculations to predict future dividend income?