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This is how equity income will make you rich

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I’ll let you into an investment secret. There is only one thing you need to get rich from stocks and shares – time. Five years, 10 years, 20 years… the more time you have at your disposal, the richer you are likely to be.

Time on your side

Yet even I was surprised by new figures showing just how much money you can make over time. The data comes from the Association of Investment Companies, using Morningstar. It shows that £100,000 invested in the average UK equity income investment company on 31 December 1996 would have more than doubled your original capital by the end of last year, 20 years later. It will now be worth a whopping £226,907, an increase of 127% over two decades.

You will have earned a lot more money than that. As its name suggests, the equity income sector will also have lavished you with dividends, producing £119,872 of income on top. The total return is therefore a whopping £346,779, well over three times your original stake.

High and rising

One big advantage of investing in dividend-paying stocks is that your income will increase over time, as profits grow, share prices rise and companies increase their payouts. So in 1997, that £100,000 would have generated £3,700 of income, at a yield of 3.7%. Last year, with the portfolio now worth £226,907, it would have generated £8,516 of income. Yet the yield is almost identical at 3.8%.

The figures show an annual rate of dividend growth of 4.5%, easily beating inflation as measured by the retail prices index, which averaged 2.78% over the period. This is increasingly valuable today with inflation forecast to hit 3%, while the average easy access savings account pays just 0.37%, destroying the value of your money in real terms. 

All you want

So investing in dividend-paying stocks gives you just about everything you want from investing: capital growth, base rate-bashing dividend yields, and an income that outpaces inflation over time. These figures assume you take the income but you have another option, which is to re-invest it for growth. That will turbo-charge your returns because every year you will own more stock, and generate rising income from that stock.

The research applies to investment trusts but you will benefit in exactly the same way if you compile your own portfolio of income-generating stocks. You might want to start with a spread of blue chips – names such as BP, GlaxoSmithKline, HSBC HoldingsRoyal Dutch Shell and Vodafone instantly spring to mind – then balance that with some lesser known companies.

Right time

As the figures above show, income stocks can make you rich. They also help you plan your future, because you can reinvest your dividends for growth when you are building your portfolio, then take them as income once you have retired. However, the data also shows that equity income will not make you rich quickly. You need to give it time. The longer you have, the more time the magical compounding effect has to work.

Income-paying stocks are the ultimate get-rich-slow investment. History suggests they are also one of the most reliable ones. Just remember that time is short, so don’t waste it.

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Harvey Jones has no position in any shares mentioned. The Motley Fool UK owns shares of and has recommended GlaxoSmithKline. The Motley Fool UK has recommended BP, HSBC Holdings, and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.