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The Simple Way To Grow A Small Investment Into A Second Income

Monday, June 30, 2014 - 10:30am

It is one of the great investing secrets...

It doesn't get much attention, partly because it doesn't have a catchy name, but it's the key factor that helps the rich get richer.

If you're not using it, to put it simply, it's going to be extremely challenging for you to earn lasting wealth. You'll have to worry about things like timing the market, finding the areas that are "hot," trying to "beat the crowd"... and generally playing the market as if it were a lottery, which is typically a loser's game.

I'm talking about compounding your dividends.

I know, I know... it's not the sexiest thing to talk about. And it's definitely not what most investors want to hear.

But rather than send you off chasing the latest fad in the market, we believe in telling our readers the truth about what it takes to be successful in the stock market over the long haul.

The truth is that dividend payments generated by a modest investment might seem inconsequential at first, but through the magic of compounding, it won't take long before they can begin to make a dramatic impact.

You see, when you buy shares of dividend-paying stocks, the dividends they pay can be used to purchase more shares, leading to increasingly larger dividend checks. These larger checks can then be used to buy even more shares and so on. In time, even a small stake in such stocks can grow into a tidy sum.

Let me show you just how powerful dividend compounding can be.

Let's say you buy 1,000 shares of XYZ Corp for $10 each -- that's $10,000 invested. If XYZ pays a 5% dividend yield, you would expect to receive $500 in dividends in the first year.

Now, rather than simply pocketing that $500, imagine if you purchased 50 more shares instead.

Of course, those 50 new shares would then generate dividend payments of their own.

So if you reinvested your dividends and left your investment alone for the second year, your 1,050 shares would generate a little more than the first year -- $525 in dividends.

If you reinvested those dividends to buy 52 more shares for the third year, your 1,102 shares (1,000 + 50 + 52 = 1,102) would pay you even more -- $551 in dividends.

Fast forward through 30 years of dividend reinvestment and your original 1,000 share stake in XYZ would have more than quadrupled to 4,322 shares.

Of course, that's a simplistic example. You would hope your shares would gain value over time rather than just stay at $10 per share.

So to complete this example, let's say XYZ's stock price gains 8% per year since your original $10,000 investment and you reinvested your dividends every year. How much would you make?

As the chart below shows, this steady compounding process can yield amazing results over the long haul.

As you can see, your original $10,000 investment would have swelled to more than $391,000, without ever adding another penny!

But what would have happened if you didn't reinvest dividends? The stock would still be worth about 10 times more than what you paid, thanks to capital gains. But without any reinvestment you would have only collected a measly $15,000 in dividends and you'd be left with the same 1,000 shares.

Granted, this is just an example, but the results are clear. Successful investing for the long haul is really nothing more than a game of compounding by earning a consistent return and reinvesting your profits back in the market over and over again. There are no shortcuts.

But here's the fun part... When your portfolio is large enough, you can stop reinvesting and live off the dividends as a second income.

It's worth pointing out that at the end of the 30-year period, the $391,000 portfolio would be generating annual dividend payments of roughly $19,550 (5% dividend yield X $391,000 = $19,550). In other words, your annual dividend income alone would amount to nearly twice your initial $10,000 investment.

Compounding gives you more time to enjoy life. You don't have to be glued to CNBC or your computer screen, looking for the next "hot" stock. And you don't have to worry about what's going on in China or Russia -- your portfolio remains largely unaffected.

The magic of compounding is most powerful when an investor focuses on established companies that throw off a steady stream of dividends. Simply find dependable companies that pay steadily rising dividends, reinvest your payments, and let the math take care of the rest.

That's why I'm telling readers of my High-Yield Investing newsletter about 23 American companies I've found that have unlocked their private pension plans to non-employees. These little-known "Second Income Plans" harness the power of dividend compounding to maximize returns over time. And unlike traditional retirement plans, they don't require you to wait until retirement age to withdraw from them. To learn more, I invite you to view this brand-new report.

Nathan Slaughter does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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