The power of the DRIP

Dividends are payouts made by a company when it is doing well, to signal its strength to existing shareholders and to convince non-shareholders to become shareholders, pay out a certain proportion of their profits to their shareholders.
There are a few things to know about them so that you can better understand what someone says when you're listening to a podcast or TV show about the markets.

The "yield" of a stock is the amount of its price it pays out every so often. So if you have a certain stock, which you own 100 shares of, each worth $100, where each share pays you 1% every quarter, then, 4 times a year, you'll get $100, earning you $400 a year.

The "ex date" is the date by which you must own shares, in order for them to be counted into the number of shares you own when the dividends payout. If in mid-May, you own 100 shares, there's an ex-date of May 25, and your next purchase is of 100 more shares, but on May 26, then, sorry! The second batch of 100 shares was bought past the ex-date, so they won't be factored into the dividend payout this time, but they will be next time for sure!

The "pay date" is exactly what it sounds like: for every share or fractional share you own, on that date, usually no more than a week after the ex-date, the company pays you the yield of that share. So let's say then that the pay date is June 1.

That means that on June 1, the 100 shares of the stock you owned by the ex-date, worth $100 each and paying out 1% of their value, will give you an extra $100 in your account.

The big brokerage firms have what are known as "DRIPs"-- that is, Dividend Reinvestment Plans. You can opt-in if you'd like. Let's assume we do have a DRIP. Since that's the case, our brokerage will take the money we got in our dividend payout, and buy more stocks for us, with that dividend money. We got a $100 dividend from our 100 shares worth $100 each, paying 1%, so participation in the DRIP bought us 1 more share this time, so we now have 101.

By participating in a DRIP, the next time an ex-date rolls around, there are more shares in our account, so our payout is bigger, so we buy more shares with the DRIP, so there are more shares in our account by the next ex-date, and so on. This is, plain and simple, the snowballing effect of compounding.

Dividend "kings, aristocrats, princes," or any other sort of royal term, are those stocks, which have been steadily increasing the value they pay out to their shareholders, per share, for a long time.

Let's make some ground rules:
1. We start with an investment of 100 shares each worth $100, for an investment of $10,000
2. Every quarter, before the ex-date, we buy $1000 more
3. The share price grows, every quarter, somewhere between 0 and 2%, but the exact amount is random
4. The yield is always 1%; the percentage of the amount won't change, but the payouts will get bigger because of rule 3, making this stock a very good candidate to be called a dividend aristocrat, if it actually existed.
5. We reinvest the money we gain from the payout by rule 4 at the beginning of each quarter

Given that, we have this table:

		Start	Gain in Market	Add before Ex-date	Dividend	End
1	Q1	$   10,000.00	1.9816%	$       1,000.00	1%	$   11,310.14
1	Q2	$   11,310.14	0.4058%	$       1,000.00	1%	$   12,479.60
1	Q3	$   12,479.60	0.2189%	$       1,000.00	1%	$   13,641.98
1	Q4	$   13,641.98	1.8332%	$       1,000.00	1%	$   15,041.00
2	Q1	$   15,041.00	1.6940%	$       1,000.00	1%	$   16,458.75
2	Q2	$   16,458.75	0.1698%	$       1,000.00	1%	$   17,661.57
2	Q3	$   17,661.57	0.7301%	$       1,000.00	1%	$   18,978.42
2	Q4	$   18,978.42	1.2625%	$       1,000.00	1%	$   20,420.21
3	Q1	$   20,420.21	1.9719%	$       1,000.00	1%	$   22,041.10
3	Q2	$   22,041.10	1.6863%	$       1,000.00	1%	$   23,646.91
3	Q3	$   23,646.91	1.8082%	$       1,000.00	1%	$   25,325.23
3	Q4	$   25,325.23	0.2863%	$       1,000.00	1%	$   26,661.71
4	Q1	$   26,661.71	1.0009%	$       1,000.00	1%	$   28,207.86
4	Q2	$   28,207.86	0.1214%	$       1,000.00	1%	$   29,534.53
4	Q3	$   29,534.53	1.2770%	$       1,000.00	1%	$   31,220.80
4	Q4	$   31,220.80	0.9706%	$       1,000.00	1%	$   32,849.07
5	Q1	$   32,849.07	1.2188%	$       1,000.00	1%	$   34,591.92
5	Q2	$   34,591.92	0.2634%	$       1,000.00	1%	$   36,039.86
5	Q3	$   36,039.86	0.1092%	$       1,000.00	1%	$   37,450.02
5	Q4	$   37,450.02	1.5992%	$       1,000.00	1%	$   39,439.41
6	Q1	$   39,439.41	1.5280%	$       1,000.00	1%	$   41,452.48
6	Q2	$   41,452.48	1.0852%	$       1,000.00	1%	$   43,331.33
6	Q3	$   43,331.33	1.8741%	$       1,000.00	1%	$   45,594.84
6	Q4	$   45,594.84	1.4764%	$       1,000.00	1%	$   47,740.67
7	Q1	$   47,740.67	1.6180%	$       1,000.00	1%	$   50,008.24
7	Q2	$   50,008.24	1.5580%	$       1,000.00	1%	$   52,305.26
7	Q3	$   52,305.26	0.1353%	$       1,000.00	1%	$   53,909.81
7	Q4	$   53,909.81	1.5662%	$       1,000.00	1%	$   56,311.70
8	Q1	$   56,311.70	0.7336%	$       1,000.00	1%	$   58,302.04
8	Q2	$   58,302.04	1.4677%	$       1,000.00	1%	$   60,759.33
8	Q3	$   60,759.33	0.3994%	$       1,000.00	1%	$   62,622.00
8	Q4	$   62,622.00	0.6160%	$       1,000.00	1%	$   64,647.83
9	Q1	$   64,647.83	0.2525%	$       1,000.00	1%	$   66,469.21
9	Q2	$   66,469.21	0.2322%	$       1,000.00	1%	$   68,299.81
9	Q3	$   68,299.81	1.4092%	$       1,000.00	1%	$   70,964.91
9	Q4	$   70,964.91	1.9207%	$       1,000.00	1%	$   74,061.20
10	Q1	$   74,061.20	1.5728%	$       1,000.00	1%	$   76,988.31
10	Q2	$   76,988.31	1.0295%	$       1,000.00	1%	$   79,568.67
10	Q3	$   79,568.67	0.3424%	$       1,000.00	1%	$   81,649.54
10	Q4	$   81,649.54	0.6684%	$       1,000.00	1%	$   84,027.27
11	Q1	$   84,027.27	1.9109%	$       1,000.00	1%	$   87,499.29
11	Q2	$   87,499.29	1.5668%	$       1,000.00	1%	$   90,768.95
11	Q3	$   90,768.95	0.4766%	$       1,000.00	1%	$   93,123.58
11	Q4	$   93,123.58	1.0377%	$       1,000.00	1%	$   96,040.78
12	Q1	$   96,040.78	0.7010%	$       1,000.00	1%	$   98,691.14
12	Q2	$   98,691.14	1.7146%	$       1,000.00	1%	$ 102,397.17
12	Q3	$ 102,397.17	0.7302%	$       1,000.00	1%	$ 105,186.31
12	Q4	$ 105,186.31	1.9110%	$       1,000.00	1%	$ 109,278.36
13	Q1	$ 109,278.36	0.6291%	$       1,000.00	1%	$ 112,075.48
13	Q2	$ 112,075.48	0.1702%	$       1,000.00	1%	$ 114,398.89
13	Q3	$ 114,398.89	0.8961%	$       1,000.00	1%	$ 117,588.29
13	Q4	$ 117,588.29	0.5652%	$       1,000.00	1%	$ 120,445.39
14	Q1	$ 120,445.39	0.6053%	$       1,000.00	1%	$ 123,396.19
14	Q2	$ 123,396.19	1.0509%	$       1,000.00	1%	$ 126,949.92
14	Q3	$ 126,949.92	1.6864%	$       1,000.00	1%	$ 131,391.75
14	Q4	$ 131,391.75	0.0098%	$       1,000.00	1%	$ 133,728.67
15	Q1	$ 133,728.67	0.7806%	$       1,000.00	1%	$ 137,130.26
15	Q2	$ 137,130.26	1.3775%	$       1,000.00	1%	$ 141,419.44
15	Q3	$ 141,419.44	1.7444%	$       1,000.00	1%	$ 146,335.19
15	Q4	$ 146,335.19	1.5200%	$       1,000.00	1%	$ 151,055.08

We can see, then, that what started as an investment of $10,000 has become more than $150,000 in 15 years, thanks to consistent growth of the stock's price, and the reinvestment of our dividends. This will prove critical. 

Behind the scenes, I'll re-produce this chart, making one small change: setting every 1% dividend payout to 0%. This will have the same effect as either not reinvesting the dividends if the company paid them out, or if the company just didn't pay them to begin with. 

If we keep everything else the same, our investment, to be sure, still does well: we would end up with about $100,000. But look at the difference between the two: $50,000 which we either were savvy enough to earn, or not savvy enough that we passed it up. Surely, any rational investor would take an option that would give them an extra 50% more money than they would have received by letting their money (and time) do the work) without almost any extra involvement on the investor's part, except to opt-in to the plan that would allow these extra gains.

This kind of investing, where the strategy is to buy and hold for decades-- with a lot more money put in each quarter, and having taken advantage of much more time to allow for compounding-- is what Warren Buffet does. He rarely, if ever, sells, so that, for instance, his position in Coca-Cola (almost 1/10 of all shares of the company) now probably makes him hundreds of millions of dollars in dividends every quarter, thanks to his past compounding efforts, and facilitating his future ones. 

That approach to dividends is a good one, but it certainly isn't the only one. 

Let's say instead that there is a couple, Bill and Brenda, who would like to retire, and they want to have a portfolio big enough that they can withdraw their dividends, instead of putting them in a DRIP and living off them. This calculation is simpler: they just would need to divide how much they want to make by the yield of their portfolio. 

	5	10	15	20	25	30	35	40	45	50	55	60	65	70	75	80	85	90	95	100
0.25%	$         2,000.00	$         4,000.00	$         6,000.00	$         8,000.00	$       10,000.00	$       12,000.00	$       14,000.00	$       16,000.00	$       18,000.00	$       20,000.00	$ 22,000.00	$ 24,000.00	$       26,000.00	$       28,000.00	$       30,000.00	$       32,000.00	$       34,000.00	$       36,000.00	$       38,000.00	$ 40,000.00
0.50%	$         1,000.00	$         2,000.00	$         3,000.00	$         4,000.00	$         5,000.00	$         6,000.00	$         7,000.00	$         8,000.00	$         9,000.00	$       10,000.00	$ 11,000.00	$ 12,000.00	$       13,000.00	$       14,000.00	$       15,000.00	$       16,000.00	$       17,000.00	$       18,000.00	$       19,000.00	$ 20,000.00
0.75%	$             666.67	$         1,333.33	$         2,000.00	$         2,666.67	$         3,333.33	$         4,000.00	$         4,666.67	$         5,333.33	$         6,000.00	$         6,666.67	$   7,333.33	$   8,000.00	$         8,666.67	$         9,333.33	$       10,000.00	$       10,666.67	$       11,333.33	$       12,000.00	$       12,666.67	$ 13,333.33
1.00%	$             500.00	$         1,000.00	$         1,500.00	$         2,000.00	$         2,500.00	$         3,000.00	$         3,500.00	$         4,000.00	$         4,500.00	$         5,000.00	$   5,500.00	$   6,000.00	$         6,500.00	$         7,000.00	$         7,500.00	$         8,000.00	$         8,500.00	$         9,000.00	$         9,500.00	$ 10,000.00
1.25%	$             400.00	$             800.00	$         1,200.00	$         1,600.00	$         2,000.00	$         2,400.00	$         2,800.00	$         3,200.00	$         3,600.00	$         4,000.00	$   4,400.00	$   4,800.00	$         5,200.00	$         5,600.00	$         6,000.00	$         6,400.00	$         6,800.00	$         7,200.00	$         7,600.00	$   8,000.00
1.50%	$             333.33	$             666.67	$         1,000.00	$         1,333.33	$         1,666.67	$         2,000.00	$         2,333.33	$         2,666.67	$         3,000.00	$         3,333.33	$   3,666.67	$   4,000.00	$         4,333.33	$         4,666.67	$         5,000.00	$         5,333.33	$         5,666.67	$         6,000.00	$         6,333.33	$   6,666.67
1.75%	$             285.71	$             571.43	$             857.14	$         1,142.86	$         1,428.57	$         1,714.29	$         2,000.00	$         2,285.71	$         2,571.43	$         2,857.14	$   3,142.86	$   3,428.57	$         3,714.29	$         4,000.00	$         4,285.71	$         4,571.43	$         4,857.14	$         5,142.86	$         5,428.57	$   5,714.29
2.00%	$             250.00	$             500.00	$             750.00	$         1,000.00	$         1,250.00	$         1,500.00	$         1,750.00	$         2,000.00	$         2,250.00	$         2,500.00	$   2,750.00	$   3,000.00	$         3,250.00	$         3,500.00	$         3,750.00	$         4,000.00	$         4,250.00	$         4,500.00	$         4,750.00	$   5,000.00
2.25%	$             222.22	$             444.44	$             666.67	$             888.89	$         1,111.11	$         1,333.33	$         1,555.56	$         1,777.78	$         2,000.00	$         2,222.22	$   2,444.44	$   2,666.67	$         2,888.89	$         3,111.11	$         3,333.33	$         3,555.56	$         3,777.78	$         4,000.00	$         4,222.22	$   4,444.44
2.50%	$             200.00	$             400.00	$             600.00	$             800.00	$         1,000.00	$         1,200.00	$         1,400.00	$         1,600.00	$         1,800.00	$         2,000.00	$   2,200.00	$   2,400.00	$         2,600.00	$         2,800.00	$         3,000.00	$         3,200.00	$         3,400.00	$         3,600.00	$         3,800.00	$   4,000.00
2.75%	$             181.82	$             363.64	$             545.45	$             727.27	$             909.09	$         1,090.91	$         1,272.73	$         1,454.55	$         1,636.36	$         1,818.18	$   2,000.00	$   2,181.82	$         2,363.64	$         2,545.45	$         2,727.27	$         2,909.09	$         3,090.91	$         3,272.73	$         3,454.55	$   3,636.36
3.00%	$             166.67	$             333.33	$             500.00	$             666.67	$             833.33	$         1,000.00	$         1,166.67	$         1,333.33	$         1,500.00	$         1,666.67	$   1,833.33	$   2,000.00	$         2,166.67	$         2,333.33	$         2,500.00	$         2,666.67	$         2,833.33	$         3,000.00	$         3,166.67	$   3,333.33
3.25%	$             153.85	$             307.69	$             461.54	$             615.38	$             769.23	$             923.08	$         1,076.92	$         1,230.77	$         1,384.62	$         1,538.46	$   1,692.31	$   1,846.15	$         2,000.00	$         2,153.85	$         2,307.69	$         2,461.54	$         2,615.38	$         2,769.23	$         2,923.08	$   3,076.92
3.50%	$             142.86	$             285.71	$             428.57	$             571.43	$             714.29	$             857.14	$         1,000.00	$         1,142.86	$         1,285.71	$         1,428.57	$   1,571.43	$   1,714.29	$         1,857.14	$         2,000.00	$         2,142.86	$         2,285.71	$         2,428.57	$         2,571.43	$         2,714.29	$   2,857.14

 Read the chart the following way:

"In order to make [column] thousand dollars a year from dividends to be withdrawn to cover living expenses if my portfolio has a combined dividend yield of [row], my portfolio needs to be at least [intersection] thousand dollars."  

So all of these are possible:

• $5,000 a year from a portfolio worth $2,000,000 paying out 0.5% dividends
• $30,000 a year from a portfolio worth $875,140 paying 3.5% dividends
• $100,000 a year from a portfolio worth $3,636,363 paying 2.75% dividends

But all of these are not possible:

• $100,000 a year from a $10,000,000 portfolio paying 0.25% (it would need to be worth $40,000,000 at that yield)
• $30,000 a year from a $666,666 portfolio paying 3% (you could only get $20,000)
• $70,000 from a $1,800,000 portfolio paying 3.5% (you could only get that much if the portfolio grew to $2,000,000, or if the yield increased)