Millionaire status may seem like an impossible goal for many people, however, with a long-term investment strategy, it's definitely achievable, in my opinion. Could dividend stocks be the secret to making a million in the stock market? I believe they could be.
A total return formula
In order to work out how to create a million pound portfolio, we first need to make some assumptions about the returns on offer from dividend stocks. One theory, that fund manager Neil Woodford has endorsed in the past, is that the expected total return from a dividend stock, over the long term, is the sum of the dividend yield and the anticipated dividend growth.
"In very simple terms, our total return expectation for a stock equals its dividend yield plus the anticipated rate of dividend growth." - Neil Woodford
The logic behind this is relatively simple. The return you receive from a dividend payout is easy to calculate. For example, if a 1,000p stock pays you a dividend of 40p, your return from the dividend is 4%.
However, if a company raises its dividend by say, 6% every year, over the long term, assuming other factors such as growth prospects or sentiment remain constant, the share price should rise at a relatively similar rate. Here's an example. Let's say the 1,000p stock above lifts its dividend by 6% for the next five years. At the end of the five years, the dividend payout has grown to 51p per share. If the share price remains at the same level in five years time, new investors could buy the stock with a yield of 5.1%. What's more likely to happen instead, is that the share price will rise over time, meaning that in five years time, the stock's yield is still around 4%.
So how does this information get you to millionaire status? Well, the lesson here is that if you can construct a portfolio of dividend stocks, in which the average dividend yield and anticipated dividend growth sums to 10%, then it shouldn't be unreasonable to expect a 10% return per year from your portfolio over the long term. From there, we can run some calculations.
Assuming a 10% return per year from dividend stocks, I calculated the time needed to build a million pound portfolio. This is what I found.
With a starting portfolio of £10,000 and a £1,000 contribution every year, you would need 41.5 years to generate a million pounds. Boost the contribution to £2,000 per year, and the time needed would drop to 37 years. Add £5,000 per year to the portfolio, and you'd hit a million within 30 years.
With a starting portfolio of £20,000 and a £1,000 contribution every year, you would need 37 years to make a million. For contributions of £2,000 and £5,000 every year, the time required would be 34 and 28.5 years respectively.
The earlier you start investing the better
The conclusion? The calculations above show that it should be possible to build a million pound portfolio, over time, with the help of dividend stocks. However, as it will take time, the sooner you start investing the better. Furthermore, the more you invest on a regular basis, the easier it is to make a million.