A retirement rule of thumb is to aim to have at least 80% of your preretirement annual income to keep your current lifestyle. So, if you currently make $100,000, your goal should be at least $80,000 in yearly retirement income. Even if you managed to save $1 million for retirement, at $80,000 annually, your savings would be gone in 12.5 years.
Here's how you can use dividends to boost yourself to millionaire status earlier and increase your retirement savings.
How long it takes to become a millionaire
One of the best ways to reach millionaire status is using dollar-cost averaging and making regular investments in a low-cost S&P 500 fund, which historically returns 10% annually over the long run. Accounting for an 0.03% expense ratio -- like that of the Vanguard 500 Index Fund -- here's how much you would have to contribute monthly to get at least $1 million:
|Monthly Contributions||Annual Return||Expense Ratio||Years Until At Least $1 Million|
How dividends work
There are two main ways to get paid for stock investments: Increased stock price and dividend payouts. Making money from stock price increases is the more obvious way, but dividends can play a vital role in helping investors reach their financial goals. Companies pay investors dividends out of their profits, and it often serves as a way to reward investors for investing in companies that may not have as much growth potential, like blue chip stocks.
Dividends are typically paid out quarterly, and the dividend yield is the percentage of your total investment you can expect to be paid annually. So, if you have $10,000 invested in a stock with a 3% dividend yield, you can expect to receive $300 annually ($75 quarterly). You can choose to receive the dividend in cash, or enroll in a dividend reinvestment program (DRIP) and have the dividends used to buy more shares of the stock, adding to the compound effect.
How dividends can boost your investments
Let's use the SPDR S&P Dividend ETF (SDY 0.51%) -- an index fund that focuses on companies that have consistently increased their dividend yield over the past 20 years -- to examine the real benefits of dividends.
With a current dividend yield of 2.7% and an expense ratio of 0.35%, here's how much you'd have if you received a 12.7% average annual total return (including the dividends), reinvested your dividends, and made the same contributions as our above example:
|Monthly Contribution||Annual Return (With Dividend)||Expense Ratio||Years||Account Total|
Even with the dividend yield remaining at 2.7%, you can see that each scenario increases by hundreds of thousands of dollars, with no additional work on the investor's end. Dividends can also take years off the time it takes to accumulate at least $1 million.
|Monthly Contributions||Annual Return (With Dividend)||Expense Ratio||Years Until At Least $1 Million|
A reward for simply holding
Dividends are rewarding because they allow investors to earn passive income by owning a stock. If you're a long-term investor, the daily fluctuations of a stock's price shouldn't worry you, especially if it doesn't result in the company cutting its dividend payout -- which likely won't happen if you're investing in well-established, fundamentally sound companies. Reinvesting your dividends and letting compound interest work its magic is a surefire way to get you closer to achieving your financial goals.