How do you generate wealth through compound growth investing?
The concept is very simple but the application through long-term dividend growth investing can be difficult until the steps are broken down. The wealth triangle guide should help you understand how to build wealth systematically.
Investing is simple in concept but yet, so many struggles with investing and generating the return on investment to meet their goals. Compounding your wealth is simply a matter of having your money continuously work for you at the best rate you risk appetite can provide.
Do you let Mr. Market do the compounding for you? or do you take it into your own hands to have a say on how fast you can compound your wealth?
Your risk appetite is a very important aspect of investing that you need to settle on early. If you don’t want risks, you accept getting lower returns and it’s a very important decision as it can ensure you don’t make emotional investing decisions at a later point. In general, you can look at a risk matrix like the below one to establish a range of performance. It is a gross approximation of risk analysis but it does represent the ranges associated with investment safety.
Got a rate of return expectations in mind?
Write it down, we will use it later on. It is acceptable that you may want different risks for different amounts in your portfolio. Overall, you will get a blended rate of return. The blended ROR is what you want to track.
Back to the investing concept, it is simple to comprehend investing but the execution is much harder to achieve the results you want. I will break down the investing challenge with the following 3 pillars defining The Wealth Triangle:
- Time Pillar- Continuously Stay Invested
- Savings Pillar – How Much Can You Invest?
- ROR Pillar – Your Compound Growth Ability – How well are your investments working for you?
Time Pillar – Continuously Stay Invested
The word ‘continuously’ is used on purpose as it is crucial when investing that you stay invested. Time is the biggest factor in compounding wealth and starting early (or now) is the single best decision you can make. Look at the numbers below to see how well time does for you.
With only $10,000, you can have $1,000,000 after 60 years.
As mentioned, if you start with $10,000 and no additional investments, it would take you 60 years to reach $1,000,000 with an 8% return. This is more than achievable.
What if you simply add $1,000 every year with the same rate of return, you can reach $1,000,000 after 50 years. Time is not something you can control but as you can see you can easily control how much you can invest. Use the rate of return that you jotted down earlier in the spreadsheet below and see where you land with your current portfolio size.
Nowadays, discount brokers and financial firms have to disclose your rate of return so you can use that as a starting point or make your own portfolio tracker to calculate your portfolio or account rate of return.
At this point, you can figure out your magic numbers to The Wealth Triangle.
- Time Pillar: How long do you have for your money to be at work. You do not control this variable, it’s out of your hands. The clock ticks and will keep on ticking. This variable depends on the other two variables.
- Savings Pillar: Your ability to save and manage your personal finance will dictate how much you can invest. The more you save, the more you can put to work. This variable is important but unrelated to investing. Even $100 per year can make you reach the millionaire club 1 year faster. Try it out in the spreadsheet and plug in your numbers.
- ROR Pillar: The return on investment your investment decision provides. Unless you invest in fixed income, bonds or GICs, your rate of return is not really known and is a reflection of your investment decisions.
The Wealth Triangle is a formula where your savings and the compound rate of return tells you how long you have to reach your goal.
Mistake to Avoid – Don’t Wait on the Sideline
Waiting on the sideline for the markets to pull back isn’t a winning strategy. You may think that you are waiting to buy low to profit later on but the market value is a daily voting machine against all the stocks in the market. It’s not a way to assess if you should be invested or not.
Each company trading on a stock exchange has a value that should be evaluated independently of the markets. In my experience during the high and lows of markets, there are always opportunities. In a well-diversified portfolio, you can usually find an opportunity as many companies (like sectors) have different business cycles.
Markets go up over time. Even after a pull back, the market will get back up and keep on going. If you waited on dips to invest, you would wait years between the dips.with a dividend yield of 1.5% versus Choice Properties REIT with a distribution yield of 5%. CNR has outperformed CHP.UN easily and has outperformed the TSX index.
To avoid putting all of our eggs in one basket and mitigate stock market risks, it is generally recommended to diversify by sector and the amount of diversification you do is very important.
I grew my portfolio to 40 unique holdings at some point and I am now down to 30 holdings. I invest in many sectors and recently dropped the basic material sector. One rule of thumb I have is to have no more than 5% in one company so that means I will have at least 20 holdings and I will aim to hold at least 2 per sector.
Your risks profile is yours only but you need to understand that the less risks you want, the lower your rate of return will be. When you plug in your rate of return in the spreadsheet, you can see the compound growth results and decide if it satisfies your goals.
If you opt to keep the rate of return and your timeline doesn’t work, all you can do is save more which is also an option as seen above. The wealth building triangle is simple and it all has to work together to achieve the results.
What rate of return should you aim for? The stock market average is pegged at 8% which is acceptable. For any 1% over the market average you want, you will need to invest time and effort in researching stocks and learning about the companies in more details.
For an investment to provide you with a good return, it needs to make a profit and grow. If it does, it will generally pay an increasing dividend and maintain a consistent dividend payout ratio. If the dividend rate increases faster than the earnings, you would see a higher dividend payout and it’s a warning sign.
A strong company that holds a competitive advantage will usually see growth. More so when the barrier of entry for new competition is prohibitive. Think of the railway companies here, could anyone decide to start a new railway tomorrow? Very unlikely and that gives the railway companies an oligopoly. Find businesses with oligopolies and you usually have a competitive advantage.
Having established how dividend can help establish patterns with revenue and management decisions through dividend growth, dividend payout ratio and EPS, investors can leverage lists of dividend stocks matching various criteria. I see all of the lists below as a starting point.
A dividend king is a dividend paying company that has paid and increased its dividend for 50+ years. There are just 17 dividend kings. It’s an impressive achievement but which is better, a company that has paid a dividend for 100 years without a fault or a company that has increased it for 50+ years. It depends is the answer as past performance is not indicative of future results but we can certainly consider it.
Hormel Foods Corporations (NYSE:HRL) has a compound dividend growth rate (CAGR) of 15.27% over 10 years while Consolidated Edison (NYSE:ED) has a dividend CAGR of 1.54% for the same period. Both are dividend kings but with different dividend growth rates. As you can see just selecting a dividend king doesn’t lead to the rate of return you would want.
A dividend aristocrat is a dividend paying company that has paid and increased its dividend for 25+ years. There are only 51 aristocrats across the S&P index. If you were to have a portfolio of 20 stocks, you could possibly choose your holdings from this pool and build a diversified portfolio.
The same different dividend CAGR can be found with the aristocrats’ list. Again, not all dividend growth stocks grow their dividends at the same rate.
The dividend achievers list requires 10 years of consecutive dividend growth and it opens up the list by a significant amount. New technology companies can soon be found on the list. This is the filter I like most for the following two reasons:
- 10 year is recent enough to reflect current management skills and goals
- 10 year has usually seen a full market cycle to highlight if the company can do well in good and bad times.
Canadian Dividend Aristocrats
Unfortunately, the Canadian dividend aristocrats rule differs from the US rules above where only 5 years is necessary and it has a forgiving rule where you can maintain a dividend rate for 1 year once included.
There are currently 87 canadian dividend stocks and REITs in the list with the same dividend growth disparity as the other lists.
Additional Dividend Investing Metrics
Using the Chowder Rule, you can establish a growth rate you want to have for your investments. It’s based on historical data, and while we know it cannot predict the future growth, companies exhibiting consistency will usually be in the ballpark. This is where the extra research is needed as you need to understand if there is an earning anomaly or if consistency is present.
I prefer to use 10 years of data for the reasons I mentioned above with the dividend achievers and it’s not easily accessible data unless you spend time reading financial reports. Dividend Snapshot Screener uses 10 years of data points to provide over 30 metrics on Canadian Dividend Stock and REITs. With a 3-year, 5-year and 10-year historical averages for dividend growth, payout ratios and EPS, we can establish consistency.
My process looks for the dividend achievers, Chowder score and the consistency to select a stock. So far, it has allowed me to build a portfolio with a 13% return over the past 9 years across US and Canadian stocks.
The Wealth Triangle Guide Summary
Time cannot be controlled but it is the most critical to your wealth. Start early and you will reap the benefits.
Increase your savings to contribute the most you can to your investment portfolio. Avoid the lifestyle inflation whenever possible and leverage your company benefits.
At last, make appropriate investment decisions to support the ROR you want and the compounding table should match your goals. It’s not easy to select investments and that’s why I spent time building a comprehensive list of dividend stocks with 10 years of data. I could not find any services for what I needed and took control of my investment decisions. If you are interested, you can build your own, or you can get a head start with the Dividend Snapshot Screeners.