If you are saving for retirement, you should aim to include not just any dividend stocks, but stocks that regularly increase their payouts over time. They can add some important stability to your portfolio as they are normally safe businesses to hold and can pay off in the long haul -- just through their dividend payments.
Here's how the passive income you collect from these types of stocks can grow over time.
Rising dividend payments can add up over time
The real value in a dividend growth stock is that over the years, your dividend income can be much higher than it is today. For example, a company that increases its dividend payment by 5% each year for 25 years will have increased its dividend income by nearly 240%, more than three times what it is paying today.
Healthcare company AbbVie (ABBV -1.03%) is an example of a safe dividend stock to buy and hold, as the drugmaker has posted a profit margin of 22% over the past 12 months. It has also generated more than $22 billion in free cash flow during that time -- more than double the dividends it has paid out to its shareholders ($9.7 billion).
Today, AbbVie pays a dividend yield of 4%. If you were to invest $25,000 into the stock, you would be collecting approximately $1,000 in dividends on an annual basis.
That's a decent chunk of change, but it can be much more significant later on. That's because the stock is a Dividend King, meaning the business has increased its dividend payments for at least 50 years in a row. In just five years, its quarterly dividend payments have more than doubled.
Its most recent increase was an 8% bump-up in the quarterly dividend, from $1.30 to $1.41. If the company were to continue growing its dividend payments by 8% per year, here's how much dividend income an investor would be collecting on a $25,000 investment in AbbVie.
Data source: Chart by author.
After 25 years of increases, the dividend income would total more than $6,800 per year and be more than 27% of your original investment, as shown in the chart.
| Year | Quarterly Dividend | Annual Dividend | % of Original Investment |
|---|---|---|---|
| 0 | $251.79 | $1,007.14 | 4.03% |
| 5 | $369.96 | $1,479.82 | 5.92% |
| 10 | $543.59 | $2,174.35 | 8.70% |
| 15 | $798.71 | $3,194.83 | 12.78% |
| 20 | $1,173.56 | $4,694.25 | 18.78% |
| 25 | $1,724.35 | $6,897.39 | 27.59% |
Data source: Chart by author.
If you were to have invested $100,000 in AbbVie, you could be generating about $27,000 annually just in dividend income after 25 years.
It's not just Dividend Kings you can consider but also businesses that are generating huge amounts of free cash flow, such as tech giant Apple (AAPL 1.27%), which has reported more than $107 billion in free cash over the past year. Its yield is modest at only 0.6% (the S&P 500 averages a payout of 1.5%), but Apple has increased its dividend payments by 46% in five years, and it could make more aggressive hikes in the future given its impressive financials.
Investors should diversify their holdings
It's difficult to predict a stock's future dividend, since payouts are discretionary and years from now, a business may not be as profitable as it is now. You can, however, minimize that risk by investing in stocks with impressive track records like AbbVie or in businesses that are gushing cash such as Apple.
But even then, it's impossible to know how much their dividend payments might increase over the long term. That's why investors should aim to buy many of these types of stocks to diversify.
Dividend growth stocks can generate a significant amount of passive income during your retirement years if you just buy and hold. That's why any long-term retirement plan should include them.
