Dividend stocks are well represented in my portfolio. That’s because I prefer the relative safety of dividends versus the uncertainty of investing in growth stocks.
To some, investing in established dividend-paying stocks may appear like a cautious approach to portfolio growth. But I don’t see it that way.
Today, I’m looking at the power of compounding, and explaining how I’d use the process to turn a regular investment of £400 a month into a giant £1m portfolio.
Aiming high
Assuming I’m starting with nothing, I’ve got to appreciate that it’s going to take time to turn £400 a month into a seven-figure portfolio.
Firstly, I’m going to want to use my Stocks and Shares ISA. That’s because it’s a tax efficient way to invest. If I reach millionaire status one day, I may want to start taking the dividends to fund my life — using the ISA, this would be tax free.
£400 a month works out at just £4,800 a year. That’s far less than the £20,000 annual limit for the Stocks and Shares ISA. Naturally, the more money I can spare each month, the quicker my portfolio could reach £1m.
From 1984 to 2022, the price return was 645.2%. The total return of the index was more than double at 1,514%. On an annualised basis, we can see a price return of 5.4%, and a total return of 7.48%.
But I think I can do a little better than that. I aim for double digits — closer to the FTSE 250‘s historic annualised returns of 11%. If I was able to achieve 11% annually, half of which I’d aim to receive in dividends, it’d take me 29 years to reach millionaire status.
If I were to carry on for 50 years — possibly the length of my woking life — I could have £10m.
Please note that tax treatment depends on the individual circumstances of each client and may be subject to change in future. The content in this article is provided for information purposes only. It is not intended to be, neither does it constitute, any form of tax advice. Readers are responsible for carrying out their own due diligence and for obtaining professional advice before making any investment decisions.
Picking wisely
Stock picking can be challenging. Of course, if I don’t pick the right stocks I’m more likely to lose money than reach millionaire status. But if I pick wisely, I could accelerate the growth of my portfolio towards £1m.
Naturally, I could pick index-tracking funds. But, for me, I’d prefer to do it myself and pick a customised-portfolio of high-quality dividend stocks.
I’m picking dividend stocks because these are the core of a compound returns strategy. It’s about reinvesting my dividends year after year. This also gives me the opportunity to allocate my annual dividends towards the best performing part of my portfolio.
Right now, I’m looking at financial stocks with strong yields and plenty of potential share price growth. Lloyds has a forward dividend yield of 6.5% and the stock could be undervalued by as much as 55% — that’s what discounted cash flow metrics suggest.
But I can also find stocks with higher yields, including Legal & General‘s 8.4%. In recent years, it hasn’t offered much in the way of share price growth but, over the long run, as Brexit issues are brushed aside, there will be some upward movement in the share price.
