Dividend snowball is pretty much a compounded interest strategy with a fancier name. This is a very effective way to invest if your investing horizon is long enough. After you have built your snowball enough, it will grow by itself, without you needing to add any more money.
How does the snowball effect work with dividends and investing?
Snowball effect and compounded interest work the same way. Basically, the snowball effect means that over time, your ball will grow larger and larger every year.
You might have notices this as a kid, when doing a snowman. First, the ball is small and barely grows every time you turn it around. However, after you have rolled the ball enough, the ball starts to gain a lot of size every turn it takes. In the end, it becomes very difficult to turn the ball even one more round, since it has become so big.
This same can be applied to investing. You start small and keep adding either your own money or just the dividends to grow your investment snowball. After it has grown enough, you don’t need to add any more of your own money. It will grow just with the dividends, just like the snowball you were rolling as a child.
One more example in numbers this time. You start investing with 1 000 dollars, the return is 10% annually, just for the sake of simplicity. After the first year, your investments have grown to 1100 dollars.
Now, you have 1100 dollars that will grow interest. Next year, you will not have 1200 dollars, but 1210 dollars. Then 1331 dollars etc. The additional 31 dollars after the third year is the snowball effect. It might not seem like much yet, but over time, it will have a huge difference.
After 10 years, if you re-invested all your dividends back into your snowball investment portfolio, you would have 2 593 dollars, instead of 2 000, if you withdrew the interest along the way.
A 10% annual return might not be realistic, but it was easy to calculate in this example. The markets have returned an average of 7-8% inflation-adjusted returns over the past decades. Keep in mind that past returns are not a guarantee of future returns.
Dividend snowball strategy
The dividend snowball strategy requires you to find good dividend stocks and then reinvest the dividends back into dividend stocks. You can either buy new dividend stocks or stick to your main ones. Remember to keep your assets diversified, meaning own enough dividend companies, not just one or two.
You might want to buy stocks from 10 different dividend companies. Therefore, even if one or two perform poorly, you have 8 more that will keep your ball rolling. Diversifying is a very important aspect of this strategy. You don’t want decades worth of dividends to go to waste because you only invested in one company.
Another important aspect is that for this to work, you have to reinvest the dividends back into your snowball. If you withdraw along the way, it can have a huge impact after a decade or two.
You also could add more of your own money during the first years of growing your snowball. At some point, the dividends will be more than your own contributions, then you can drop them off. At the beginning, your own contributions will make a big difference in the future.
When do dividends start to snowball?
Dividends start to snowball from the first day you reinvest your first dividends. The snowball effect at the beginning might not be noticeable or huge, but overtime it will grow.
After your snowball has been rolling for some time, it will start to roll on its own. You no longer need to make monthly contributions. They don’t make so big difference when your portfolio has grown enough. You still can add more and more of your own money, but it is not necessary when your additions are just a tiny part of the annual growth.
Do you need dividend companies to snowball effect?
No, you don’t necessarily need dividend stocks to get the snowball effect. The companies might not pay any dividends but reinvest the profit straight back into the company itself. Therefore, the value of the company will grow, making your snowball grow as well.
This could be a better option if you have to pay taxes on dividends. When you don’t have to pay taxes along the way, your snowball will have more assets to grow. You could also do both with your snowball portfolio; buy both growth and dividend stocks. This can be a good way to diversify your portfolio.
How do stocks compound without dividends?
Like I mentioned above, stocks don’t necessarily need to pay dividends to get the snowball effect. They could reinvest the profits right back into the company, making it more valuable, and this way get the snowball effect.
This way your portfolio will grow more tax efficiently when you don’t have to pay taxes on dividends. They are pretty much tax-freely invested back into the company and that will also grow the value of your portfolio.
Final words
This was a guide for dividend snowball, hopefully you now know how the snowball works and also things to keep in mind when creating your snowball. One main thing is diversifying. Don’t put all your assets into one dividend stock; it can be a dangerous path to go.
Other investing-related posts can be found here.
Have a nice day.
This is not investment or financial advice. Always do your research before risking your hard-earned money. Past returns are not a guarantee of future returns.