I am going to start this post with a quote from a famous and brilliant man everybody knows: Albert Einstein
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
To illustrate this concept I wanted to share with you the application in dividend investing. The 1st chart shows a well known company 3M. As you can see below, most of the total return came from reinvesting dividends over time. Now agreed, it takes time for the compounding to get traction, but once it does the results are astonishing. So to give an example if you had invested 10 000$ in 3M in the early 2000’s you would end up with 20 000$ in 2013 if the company pays no dividends, but thanks to dividends you actually get 34 400$!!!! Let’s say it’s a nice boost to your total return.
I also wanted to share another graphic that shows why companies that have an economic moat and can grow dividend payments over time usually beat with a good margin most known indexes. I took in this one Johnson & Johnson vs the SP 500 index. You can also see that JNJ handled 2002 recession & 2009 financial crisis better since the blue line didn’t drop like the orange one…. Stable companies that pay dividends tend to be less volatile as well.
So yes it takes time to see the compounding take effect, don’t get discouraged in the first 5 years and start investing when you’re young. There is no way to compress compounding magic unfortunately.