On my website, I often talk about investments, but very rarely do I discuss the process to accumulate a nest egg. I often assumed that investors who read my site are there because they have the cash. However, some feedback in my previous article, where I outlined the benefits of dividend investing for young investors, made me realize that an article on the subject might be a good idea.
There are essentially a few major ways for an ordinary investor to accumulate a nest egg. The first way is by contributing or maxing out your 401k and IRA, and let it compound tax-free for several decades until you reach your target retirement date. At this stage, you can follow the traditional four percent rule.
Or you could decide to embrace dividend investing by selling your index funds and purchasing individual dividend growth stocks. This could be done a few years prior to your target retirement date on several tranches. For example, if you have a $600,000 in a 401k and five years to retirement, you can essentially sell $1000 worth of index funds and purchase $1000 worth of dividend stocks every month for 60 months. The value of your index funds will fluctuate as you perform this exercise, and the mathematics will be different for every investor, but the idea should be fundamentally sound and easy to follow.
Of course, you can decide to convert your 401K by selling off your index funds, rolling the proceeds into an IRA, and then buying as much dividend paying stocks as you can get your hands on. I rolled over an old 401K in April, and replaced the index funds with a portfolio of twenty dividend paying stocks.
Below, you can view the annual contribution limits for 401K plans for individuals below 50 years of age since 1987.
If you maxed out your 401K between 1987 and 2012, and invested in an S&P 500 Index Funds (VFINX), your portfolio would be have been worth over $738,000. I assume dividends were automatically reinvested during those 25 years, and all of the money was invested at year-end. I do not account for any catch up contributions in this scenario.
The second way to accumulate your nest egg is to focus on income only. You can put the bare minimum in 401K or IRA plans, and then invest most of the funds in a taxable brokerage account In this account the investor will be able to invest in anything they want, and have the flexibility to either spend the dividends or reinvest them in more stock. This is the ideal method for anyone who plans on retiring in their 30s or 40s. With this method however, the accumulation of funds might be slower than with the first one, since it is done with after-tax money.
As I mentioned in an earlier article, someone who is saving $3,000 per month in dividend growth stocks yielding 4% and growing distributions at 6% per year should be able to generate $4,000 per month in 15 years. If you put $1,000 per month, in 15 years you would be able to earn approximately $1,330 per month in passive dividend income.
The types of dividend stocks I could purchase today, which would allow me to pursue option two include:
Philip Morris (PM), through its subsidiaries, manufactures and sells cigarettes and other tobacco products. The company has raised dividends for years in a row. Over the past five years, Philip Morris International has managed to raise dividends in each year. The stock trades at 16.90 times earnings and yields 3.90%. Check my analysis of Philip Morris International .
Wal-Mart (WMT) operates retail stores in various formats worldwide. The company has raised dividends for 39 years in a row. Over the past decade, Wal-Mart Stores has managed to raise dividends by 18.10% per year. The stock trades at 14.70 times earnings and yields 2.50%. Check my analysis of Wal-Mart.
McDonald’s (MCD) franchises and operates McDonald’s restaurants in the United States, Europe, the Asia/Pacific, the Middle East, Africa, Canada, and Latin America. The company has raised dividends for 36 years in a row. Over the past decade, McDonald’s has managed to raise dividends by 28.40% per year. The stock trades at 18.60 times earnings and yields 3.10%. Check my analysis of McDonald’’s.
Chevron (CVX), through its subsidiaries, engages in petroleum, chemicals, mining, power generation, and energy operations worldwide. The company has raised dividends for 26 years in a row. Over the past decade, Chevron has managed to raise dividends by 9.60% per year. The stock trades at 9 times earnings and yields 3.40%. Check my analysis of Chevron.
Realty Income (O) is a publicly traded real estate investment trust. It invests in the real estate markets of the United States. The company has raised dividends for 19 years in a row. Over the past decade, Realty Income has managed to raise dividends by 4.20% per year. The stock trades at times FFO and yields 5.20%. Check my analysis of Realty Income.