Creating A Dividend Portfolio For Young Investors

By Aaron Levitt | September 13, 2012 AAA
Creating A Dividend Portfolio For Young Investors

Dividend growth investing definitely appeals to an older audience. After all, steady reliable dividend payments are exactly what retirement is made of. On the flip side, younger investors with plenty of time on their hands often choose growth and capital appreciation as their major goal. Why invest in a boring consumer products firm like Kimberly Clark when that money could be socked into shares of the latest highflier tech IPO?

Well, younger investors couldn't be more wrong if they tried. The truth is that younger investors need to realize that 90% of stock market returns come from dividends and dividend growth. Albert Einstein called compound interest one of "the greatest mathematical discoveries of all time." The basic idea is that compounding is the process of generating earnings on an asset's reinvested earnings. To work, it requires both the re-investment of earnings/dividends and time. The more time you give your investments to compound, the more you are able to accelerate the growth and income potential of your original investment. Younger investors have an unfair advantage versus their older peers in this regard.

Given that dividends and compounding play such an important role in future returns, exactly how do younger investors switch focus and turn their attention toward dividend growth investing? Here are some tips.

Building a Better Mousetrap
Building a portfolio of stable dividend-paying equities is simple and represents the true heart of investing - buying ownership of a company. By focusing on the strategy when young, investors have more time to let compounding work its magic.

Famed value investor Benjamin Graham outlined the rules for building a core portfolio of stocks in his book, "The Intelligent Investor" (1949). Two of those rules are incredibly important when it comes to creating a dividend portfolio. Firstly, each stock held should be large, prominent and conservatively financed. Secondly, each company should have a long record of continuous dividend payments. By focusing on these factors, investors can find sustainable dividend payers.

Ratings agency Standard & Poor's does much of the legwork for investors when it comes to these two rules. Each year, the agency publishes its S&P Dividend Aristocrats list, which features firms that have raised their dividends for 25 years or longer. While there are no guarantees that these firms will continue to crank out the dividends - some former members of the list did cut payouts during the Global Credit Crisis - the Aristocrats are as close to a sure thing in the investing world as you can find. The list provides a great starting point for would-be dividend growth investors.

Using that list as a framework, younger investors should focus their efforts on targeting companies that produce products likely to remain in demand 20 or 30 years from now. This is a crucial point to consider, as building wealth through dividends is a long-term commitment. There have been plenty of firms in the Dow Jones Industrial Average that were standard-bearers for their industries back in the day, only to be passed by technological advances. Choosing businesses that have a transparent growth trajectory will make it easy to see how they'll grow earnings over time. For example, it's easy to see how ExxonMobil will do because it's tied to growing worldwide energy demand. Finally, setting aside a consistent amount of money every month is key to seeing the plan work.

Taking the Broad Approach
For those young investors without the time to sift through a wide universe of dividend payers or who still do not want to bother trying the style, they may want to consider a dividend-focused exchange-traded fund (ETF) or a mutual fund. A number of funds provide portfolios with broad exposure to dividend-paying equities.

The two largest ETFs in the space are the iShares Dow Jones US Select Dividend (NYSE:DVY) and the Vanguard Dividend Appreciation (NYSE:VIG). The iShares' fund focuses more on high yield stock, while the Vanguard fund tracks U.S.-based stocks that have grown their dividends for the past 10 consecutive years, while meeting a specific liquidity requirement. Young investors with their long timelines can reinvest the fund's dividend payments and can achieve similar results to a do-it-yourself approach.

The Bottom Line
They say that youth is wasted on the young. In terms of dividend investing, that fact holds true. By focusing on this style, younger investors can truly put the magic of compounding to work. The previous tips are a great way to get started in the search for long-term dividend growth.

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