My mind was wandering, the usual subjects… DRIPs, Dividends, Compounding (yum). The wealthy get wealthier, the more you have the more you make, right? Hmmm. I started thinking of possible ways one could take even more advantage of compounding while DRIPing stocks. I initially doubted anything could be done. Buy shares, DRIP, get more shares, done. Right? I mean, a YoC% is constant, and does not depend on the amount of capital you have invested, right?? No matter how big the base of your pyramid is, the % of compounding will be the same. Let’s see…
What I came up with is a hypothetical classification system for compounding that would apply to stocks:
- Softcore/Slow/Linear compounding
- Hardcore/Fast/Exponential compounding
Please allow me (and yourself) to dream a little for this explanation, as the numbers can become fairly impressive.
This is the regular good old compounding. I begin by looking at the usual metrics:
- Yield % and $
- Dividend distribution schedule (monthly, quarterly, yearly)
- Price-per-Share $
- DRIP discount (when available) %
First, I ask myself how many shares I would need to generate a NEW share every time I receive a dividend.
The example stock I’ve chosen is Emera Inc (EMA.TO). I have taken the info on the Canadian All-Star List for July 2017, so the exact numbers such as price-per-share might be slightly off.
- Yield 4.5% at $0.5225/Share
- Div is given quarterly
- PPS: $46.40
- DRIP Discount: 5% (I will bypass this for the sake of my example, but this is sweet!)
So? How many baseline shares do I need, to generate 1 new share every time I’m paid?
$46.40 / $0.5225 = 88.8 rounded up = 89 shares.
This would be my regular compounding strategy for generating new shares.
BUT, because only whole shares are bought and contribute to the compounding of the next cycle, I will keep getting 1 new whole share for 89 quarters (AKA over 22 years), at which time I will have 2×89 shares, and will earn TWO new shares every quarter. This is why I call it slow compounding. Isn’t there a way to speed this up?
Isn’t there a way I could make more of my money work for me?? If I now ask myself how many shares I would need for my GENERATED shares to earn me a NEW share every time I get paid, I create a hardcore/fast compounding scenario. So… I need 89 shares to generate one NEW share, therefore I need my baseline amount of shares to generate 89 shares. 89×89 = 7,921 Shares! That way, in the first dividend cycle I will be getting 89 shares, then 90… then 91… etc. But, does it actually make a significant difference in the ultimate YoC? Let’s see what we get using the same company as an example.
Softcore VS Hardcore
I’ve created a spreadsheet to simulate the 2 scenarios. (I have tried using the online calculators but they don’t take into account that you only DRIP into full shares and not fractional shares, like funds.)
I’ve calculated the 5yr and 10yr YoC. At first the difference is minimal. The 5yr YoC is 0.162% more in the Hardcore scenario. After year 10, the YoC difference is up to 1.4%. Significant, but not dramatic.
What is dramatic, though, is the initial investment required to benefit from that small 10yr advantage: almost $370,000! Well, I guess it is true that the more money you have, the more you make. But, more precisely: the more stocks your stocks can generate, the more money you make.
While for this particular example, the initial amount is ridiculous. I am sure that there are many more higher yielding, and lower PPS stocks out there that could bring the initial investment closer to $100K. Plus, I didn’t even add the 5% DRIP discount. Which would change the Softcore and Hardcore initial investments to $3,944 and a measly $335,240, respectfully.
I have shown that it is technically possible to slightly boost your compounding, by getting your compounding to compound! Unfortunately, It really has little to no real-life applicability for the vast majority of investors. I have also shown that the difference between the two scenarios is small, consequently, that the ”Softcore” compounding is Hardcore enough!
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