Reinvesting your dividends is possibly one of the simplest ways to get rich with minimal effort.
In fact, the S&P 500 Total Return Index currently stands at about 3,200 -- a full 78% higher than the standard S&P 500 index at current prices. Indeed, it is easy to see how quickly total returns and dividend reinvestment can boost your portfolio. In particular, if we look at the annualized returns of the S&P 500 compared to those of the S&P 500 Total Return Index, we can see that on an annualized basis the S&P 500 Total Return Index has outperformed the S&P 500 by 2% to 3% per year.
If we look at the returns within Europe, it is even more impressive. For example, since January 1990, the S&P 500 has produced a compounded return of 38.7%. However, during the same period -- a period that saw two serious market crashes -- the MSCI Europe High Dividend Yield Index has returned 80%.
Still, you would be surprised how many investors actually disregard this simple rule.
Bigger is not always better
Nonetheless, in the world of dividend investing, bigger is not always better. Indeed, consider the high-yield mortgage real-estate investment trusts, or mREITs, such as Annaly Capital Management, which has been forced to slash its dividend recently due to uncertainty within debt markets. Moreover, according to Google Finance, Annaly has barely managed to keep its payout steady for two consecutive quarters.
On the other hand, Diebold (NYSE:DBD), which currently offers a comparatively low yield of only 3.9%, has paid and increased its dividend for 60 consecutive years. Diebold's history as a company stretches back to 1871, when the Great Chicago Fire destroyed everything within a four-mile radius except for 878 Diebold safes, which remained intact. Diebold is now in charge of protecting such items as the U.S. Constitution, the Bill of Rights, and the Declaration of Independence. With such a rich history behind it, Diebold's services are likely to be in demand for many years to come. In addition, Diebold's reputation and heritage give the company pricing power -- the ability to maintain a good level of profit on everything it sells.
Historically, companies with pricing power like Diebold's have been more dependable when it comes to dividend payouts. And when it comes to dividend investing for the long term, factors like reputation and pricing power need to be considered.
As with all successful investing strategies, picking candidates for successful long-term dividend-reinvestment requires that you seek diversification. Diversification on a company level is almost as important as diversification on a portfolio level. For example, Reynolds American has a great history of dividend performance. The company's payout history stretches back more than three decades. However, the consumption of cigarettes is declining within the U.S., and over time it is likely that the company's earnings will come under so much pressure during the next few decades that the dividend will have to be cut.
However, you can't get much more diversified than Johnson & Johnson (NYSE:JNJ), which has a list of products in sectors that would be too long to list here. Johnson & Johnson has paid a dividend for 51 consecutive years, and the payout has grown annually as well. Still, like Diebold's, Johnson & Johnson's yield is less than impressive: At 2.8%, it is around the same as the market average. Nonetheless, it is worth accepting a smaller payout for greater dividend security. Indeed, according to data from Dividend Channel, since 1995 Johnson & Johnson stock has returned 680% with dividends reinvested. The S&P 500's total return over the same period was 323%.
The best of both worlds
Of course, a larger-than-average dividend yield, long payout history, and strong company are the three most desired factors in any dividend stock. Altria (NYSE:MO) meets all of these criteria.
Now, you might be doubtful about this choice, as Altria is a tobacco company. However, the company's payout history stretches back 43 years, and it currently offers a 5.1% dividend yield. Moreover, although the majority of Altria's income comes from cigarette sales, the company also has a smokeless division, wine estates, and a 27% stake in SABMiller. These three bolt-ons give the company some diversification.
Once again, according to Dividend Channel, we can see that Altria's total return since 1995 is 1,640% with dividends reinvested -- 400% more than the S&P 500.
These returns are almost second to none, and this long-term outperformance really gets me excited about Altria's future.
So, in conclusion, if you want to make money with little effort, then reinvesting your dividends is the way to go. However, it's not as easy as it seems, and you need to pay careful attention to which investments you choose. In the world of dividend investing, bigger is not always better, and the company's payout history should always be considered.