With patience you can use dividend snowball investing to compound your way to earning incoming levels from your dividend stocks that will pay your bills and allow you to be financially independent.
Have you ever built a snowman (or snowwoman!) by rolling snowballs on the ground to build the body? With each roll the snowball, it becomes a little larger. And with each roll, because there’s more surface area, the snowball starts to grow larger faster. Dividend snowball investing works on the same concept.
How Dividend Snowball Investing Works
The original concept for dividend snowball investing pulls from David Ramsey’s debt snowball method, where you see an increasing speed of paying off debt by prioritizing the smallest balances for payoff first. With each payoff, you use the extra money on the next balance. Rinse and repeat until all of your debt is paid.
Dividend snowball investing focuses on the compounding effect of reinvesting dividends back into the same investment so that with each dividend payout you receive a slightly larger dividend payment in the future. With enough patience (and time) assuming you invested in strong companies, the growth effect is amazing.
If you do not reinvest the dividends or in some way increase the shares that you have in a particular company, your dividend increases will only come from annual dividend payout increases declared by the company. For example Coca-Cola (KO) annually increases it’s dividend.
If you have 20 shares of KO and take the cash instead of reinvesting, each year you will receive a slightly larger dividend payout. If you reinvest that dividend payout into partial shares of KO, each payout grows slightly faster because there are additional shares plus the larger per share payout.
The only other way to receive additional shares if you don’t reinvest or purchase new shares, would be a stock split (though the dividend is also split) or through a merger that results in new shares. Both would give you a boost in the long term ownership and dividend payouts, but neither are usually frequent events.
Deciding to reinvest your dividends or not
Dividend snowball investing requires additional shares to be created (or purchased), in addition to annual payout increases for the method to be most successful.
Automated Reinvestment vs manually purchasing shares
For anyone that follows dividend investing blogs, there are strong opinions on if you should automatically reinvest or take the dividend cash. Some people will argue to watch the price of the stock to determine if it’s the right value. Could you find a better investment elsewhere? This may be true, but don’t forget that you’ll likely need to pay a trade commission if you use the money to make purchase.
Run the math on how many shares you may receive
One of the first mistakes I made when I started dividend investing was that I didn’t do the math to determine how many partial shares I would receive based on the current dividend and the number of shares I was about to purchase.
Reinvesting dividends into partial shares is great until you realize that you’re only receiving a .001 share of stock. That’s going to take YEARS to reach 1 full share.
And tip, if you need to move your investments between investing houses, those partial shares will be liquidated, because they can only transfer WHOLE shares. YEAY, paperwork for the next tax year and you’re back where you started.
My 2-cents, for each company you are thinking about investing in, reverse engine how many shares you need to reach either one quarter of a share per year at a minimum. Of course this isn’t a guaranty given price fluctuations, but it’s enough of a guideline to help you actually make progress on growing your holdings. Depending on the dividend yield of the stock, you may receive a bit of sticker shock on how much you need to invest.
Don’t take this as a hard rule for investing and potentially invest what you can at the time and purchase more shares in the future. I’ve done that too.
Make sure you purchase a stock with a history of paying dividends
This probably goes without saying, but to improve your chances of a successful buy-and-hold growth strategy, you need to purchase shares from a strong company with a long history of paying and increasing dividends. Companies such as the dividend kings that have at least 50 years of paying dividends are a “safer” bet. Nothing is guarantied, especially in the stock market.
And PS, don’t forget about taxes
One of the things I didn’t understand early on, when I actually started paying attention to my taxes, was that you have to pay taxes on your dividend income even if you reinvest it. Check with your favorite tax professional (or a nifty tax prepration software) for more information.
If you’re invested in a company that results in qualified dividends (in general most blue chip stocks), you’ll pay a lower tax rate compared to an investment that pays ordinary dividends (potentially a REIT – Real Estate Investment Trust).
When I am deciding between a few different companies for an investment purchase, among other criteria to check such as company health, I also take a look at the current dividend yield to decide which pays better after taxes, especially if I’m investing in a taxable account as opposed to an IRA or tax deferred account. I want to be the most efficient with my investment purchases, at least for that time.
Over to you. What do you think about the Dividend Snowball Investing?
Have you tried dividend snowball investing? What’s worked well for you? Where have you had trouble? What tips can you share?