Given enough time, you can earn substantial wealth from compound interest on decent returns on your investments. What’s a good return on investment? You can use market returns as a gauge. For example, since 2003, the Canadian stock market return (using the iShares S&P/TSX 60 Index ETF as a proxy) has grown at a compound annual growth rate (CAGR) of approximately 8.6% (According to the rule of 72, investors would have doubled their money in about 8.4 years.).
Therefore, stocks that have beaten this return in the period could be a good investment. For example, Bank of Montreal (TSX:BMO) has delivered annual returns of about 9.6% in this timeframe. In fact, the stock is down about 17% in the last 12 months.
The weakness in the dividend stock could be an excellent buying opportunity for long-term investment. This is especially so since the big Canadian bank stock offers a higher dividend yield than the market. Assuming this dividend is safe (which I believe it is), investors can get more stable returns from BMO stock, which relies less on price appreciation than the stock market for returns.
The power of compound interest
Let’s take a look at BMO’s historical results for reference. Over the past decade, the bank increased its adjusted earnings per share (EPS) at a CAGR of 8.2% and dividend per share at a CAGR of 6.2%. Its 10-year total returns were roughly 10.2% per year (i.e., price appreciation of 7.4% and 2.8% from dividends annually). In other words, its dividend payments contributed to more than 27% of total returns.
At writing, BMO stock offers a fabulous dividend yield of 5.18%, which is higher than the 4.8% yield 10 years ago. Investing $10,000 today would make $518 in passive income annually. Assuming it’s able to grow its adjusted EPS 6% and dividend per share by 5% annually, and the stock appreciates 5% per year, an initial $10,000 investment will grow to about $16,289 in 10 years.
If the dividend yield remained at 5.18%, the stake would earn close to $844 in passive income annually (up almost 63% from $518). So, it would be a yield on cost of 8.4%. In other words, investors would earn north of 8.4% every year from dividends alone from then on assuming the stock increased its dividend over time.
How to fuel your wealth creation
While getting solid returns on your investments over time will make you wealthier, as shown in the example above, there are ways you can fuel faster wealth creation. You can reinvest your dividends for more shares in quality businesses. Additionally, you can regularly save and invest. For instance, you can invest $1,000 in your best stock idea every month or every few months. Just remember to spread your risk across a diversified portfolio.
Investor takeaway
It’s always the hardest to start something. It might not seem like much to make $518 per year in passive income on an initial investment of $10,000. However, slow and steady wins the race. Keep saving and investing regularly. If you invest in a basket of quality dividend-growth stocks, you will only make more and more passive income from your portfolio. Over time, the $518 per year could turn into $5,000.
Keep track of the growing dividend income per year you’re earning from your portfolio to encourage yourself in this lifelong journey. The increasing income may be from new investments from your regular savings or dividend increases from your holdings.
