Money Making Money

The other day, on our Living Below Your Means discussion board, MissMemphisBelle shared a very interesting -- and important -- message:

"I looked at my 401(k) balance today. Hadn't checked it in a while. I've contributed to my 401(k) religiously over the years, and I'm finally to a point where I have a pretty good sum of money in there, in several different types of funds. Not enough to say 'take this job and shove it' any time soon, but at least I'm starting to see that it will be a possibility when I'm ready.

"Today, when I checked my 401(k) balance, I saw that all of the final dividends have been paid for the year. It was over $1,200, just this month!! Woot!"

Then she uttered some words that every investor needs to appreciate:

"The snowball principle at work, for me! That $1,200-plus bought more shares, which will pay more dividends ... and that'll buy more shares ... which will pay more dividends ... and hopefully the shares will increase in value, too!"

A beautiful double-whammy
She's painted a very pretty picture. Think about it. Over time, she socked away sums of her hard-earned money, and she's already seeing significant rewards from it. If her current overall dividend yield is in the neighborhood of 3%, that means the value of her nest egg may be not far from half a million dollars. While she's still working, she can continue to contribute to her plan, adding more dollars. But it's also true that she could just sit back now and watch her investments grow on their own, significantly.

Most people with 401(k)s don't have as much money as she does socked away. Just to get a sense of how powerfully your wealth can grow with even a modest 401(k) account, let's assume she has accumulated just $40,000 so far. We'll also imagine that she earns 2.5% in dividends annually, her investments grow 8% annually, and she invests no more money:

Year	End with
1	$44,200
5	$65,898
10	$108,563
15	$178,852
20	$294,649
25	$485,419

And if she adds $3,000 to the pot each year:

Year	End with
1	$47,200
5	$84,396
10	$157,537
15	$278,032
20	$476,542
25	$803,576

See how relatively little sums like $3,000 can make such a big difference? See how much wealth she'll be building even if she spends that $3,000 on trips or other luxuries?

Dividends can turbocharge your portfolio
It's helpful to think of dividends the way MissMemphisBelle presented them -- as assets that beget assets that beget assets. Even if a stock or mutual fund is stagnant for a while, if it spits out dividends, you'll be increasing your wealth despite the stagnation.

You can enjoy this kind of snowballing effect outside a 401(k), too -- such as if you invest in individual stocks that pay dividends, through a regular brokerage account.

Finding good dividend payers
If you want to find some companies that pay steep dividends relative to their stock price, you can run screens on various websites. Here's one that gives us the Dow component companies with dividend yields north of 3%:

• General Motors: 10%
• Verizon Communications: 5.2%
• AT&T: 5.4% (NYSE: T)
• Merck (NYSE: MRK): 4.6%
• Altria (NYSE: MO): 4.3%
• Pfizer (NYSE: PFE): 3.9%
• Citigroup (NYSE: C): 3.9%
• DuPont (NYSE: DD): 3.7%
• JPMorgan Chase (NYSE: JPM): 3.6%

Should you snap some of these up? You might, but you'd better be picky. That GM yield of 10% may be mighty tempting, but remember that the company is struggling right now, with bankruptcy a possibility. Also remember that dividends occasionally get reduced or eliminated when a company is in trouble. And even if the dividend remains in place for a while, who's to say the stock price won't sink further, erasing any gains from dividends? Sometimes a dividend yield is high for a reason -- because the underlying stock has sunk because of problems.

Study dividend-paying candidates (and any stock you're considering, for that matter) carefully. If you'd like some help with your homework, I invite you to give our Income Investor newsletter service a whirl -- for free. In more than two years of monthly recommendations, lead analyst Mathew Emmert has racked up an average gain of 13%, topping the S&P 500's return handily. Fully 27 of his recommendations, last time I checked, offered yields above 4%, many of them much more than that.

Learn more in these Mathew Emmert articles:

• Think Dividend Stocks, Not Bonds
• How to Achieve 20% Yields
• Extra Dividends, Extra Growth
• More Money, Less Risk
• Dividend Stocks Beat the Market

Selena Maranjian's favorite discussion boards include Book Club, Eclectic Library, and Card & Board Games. She owns shares of Pfizer, which is a Motley Fool Inside Value recommendation. Merck and JPMorgan are Income Investor recommendations.For more about Selena, viewher bio and her profile. You might also be interested in these books she has written or co-written:The Motley Fool Money GuideandThe Motley Fool Investment Guide for Teens. The Motley Fool is Fools writing for Fools.