Famous scientist Albert Einstein acknowledged the power of compounding as the eighth wonder of the world. This compounding can convert a $300 monthly investment into a $338 monthly income. Today, we will understand compounding and how to harness this power to grow your money.
Understanding the power of compounding
Suppose you run a lemonade stand. You invest the first $100 of your money to buy lemons and sugar. Let’s say you earn $130 from selling lemonade. You reinvest the entire $130 to buy more lemons and sugar and sell more lemonade. If you now earn $160, you reinvest and keep earning more. These small, consistent steps keep adding to your effort, and gradually, the business grows. That’s the power of compounding.
A financial goal, no matter how big, begins with the first investment. You need small, regular investments for a long time. And to help you with this, many dividend stocks offer dividend-reinvestment plans (DRIP).
In a DRIP, the company does not pay you the dividend. Instead, it reinvests the dividend to buy more of its shares on your behalf. You might think it will increase the company’s share count and dilute the earnings per share. But that is not the case. The company keeps buying back shares from the market, maintaining a balance of the share count.
How does compounding work in investment?
As an investor, you can harness the power of compounding by staying invested for the long term. Since dividends are taxable in the hands of the investor, try investing in a DRIP through registered savings accounts to get a tax exemption. And since the company itself is issuing you DRIP shares, you need not pay any brokerage. Moreover, the company offers a 1-3% discount on the average stock price of DRIP shares.
One good DRIP share is CT REIT (TSX:CRT.UN), which annually grows its distribution by over 3%, adjusting your passive income for inflation. The real estate investment trust (REIT) can do so because more than 90% of its properties are leased to its parent, Canadian Tire. The REIT increases its rent by 1.5% annually. It keeps developing and enhancing new stores to earn higher rent. It paid out 74.8% of its funds from operations as distributions in 2023, despite falling property prices.
Since it gives a monthly payout, the distribution amount is compounded monthly. However, for ease of calculation, I have taken annual compounding. Hence, your actual income could be more than what we calculate here.
How to convert a $300 monthly investment into a $338 monthly passive income
| Year | Annual Investment | CT REIT DRIP Shares | CT REIT Share count | CT REIT Dividend per share (3% CAGR) | Total dividend |
| 2024 | $3,600.00 | 218.0 | 218.0 | $0.90 | $196.20 |
| 2025 | $3,796.20 | 230.1 | 448.1 | $0.93 | $415.36 |
| 2026 | $4,015.36 | 243.4 | 691.4 | $0.95 | $660.18 |
| 2027 | $4,260.18 | 258.2 | 949.6 | $0.98 | $933.91 |
| 2028 | $4,533.91 | 274.8 | 1224.4 | $1.01 | $1,240.27 |
| 2029 | $4,840.27 | 293.3 | 1517.8 | $1.04 | $1,583.54 |
| 2030 | $5,183.54 | 314.2 | 1831.9 | $1.07 | $1,968.65 |
| 2031 | $5,568.65 | 337.5 | 2169.4 | $1.11 | $2,401.28 |
| 2032 | $6,001.28 | 363.7 | 2533.1 | $1.14 | $2,887.99 |
| 2033 | $6,487.99 | 393.2 | 2926.3 | $1.17 | $3,436.37 |
| 2034 | $7,036.37 | 426.4 | 3352.8 | $1.21 | $4,055.26 |
You invest $300 every month in CT REIT. Even if you miss investing in a month, you can make up for that month in future months. Maybe invest $100 extra in the next three months. Or you can invest the entire $3,600 in one go if you have the money.
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In any case, you have invested $3,600 in 2024. I took the REIT’s average stock price of $16.5. If you invest now, you can buy it at a discounted price of $14.26 and buy more units. Taking a conservative approach, a $3,600 investment will buy you 218 units that pay $0.90 distribution per share annually. In 12 months, you will earn $196.2 in dividends.
Next year, you invest $3,600, and the REIT invests $196.2 to buy you 230.1 shares. In the DRIP, the share count can go into decimals. Initially, this amount might look small, but the amount grows as time passes. As you can see in the table, the dividend amount ($4,055) surpassed the $3,600 contribution by 2034. And 3,352.8 shares can give you a monthly passive income of $337.94 ($4,055/12 months).
