Here's how your dividends can help to generate even more dividends

There’s probably nothing more joyful than hearing that “ka-ching” when a dividend cheque lands in your bank account.

Of course, the days of receiving dividends in the mail are numbered as electronic transfers eventually take over this manual process.

What hasn’t changed, though, is the ability to enjoy a passive flow of cash just by buying dividend-paying stocks .

Here in Singapore, an income-focused investor can find many opportunities to load up on companies that pay a steady, consistent dividend.

One example is REITs , which are well-known for being dividend vehicles as they have to pay out 90 per cent of their earnings to enjoy tax benefits.

Even during this crisis, certain REITs haven’t been badly affected and can continue to pay out dividends to their unitholders.

What’s more intriguing, though, is the ability to grow your passive dividend flow over time.

This is akin to planting a tree now to enjoy the fruits of success many years later.

Here’s how you can tap on your dividends to generate even more dividends down the road.

1. Turning on the tap

For a new investor, you can start by deploying some money into dividend-paying stocks.

Those who have just started working and saving may not have a lot of funds for investment, but that’s all right.

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You can start investing in REITs with as little as $1,000 , and then gradually build up your investment portfolio.

The important thing is to start turning on the dividend tap, even though it may only be a trickle, to begin with.

Don’t feel discouraged as it takes time, effort and patience to turn that trickle into a gush.

2. Steadily-rising dividends

The next step is to select companies that have strong fundamentals and can enjoy sustained, multi-year growth.

As their business improves and profits and cash flow rise, they should also naturally pay out increasing dividends.

The key is to choose companies that not only demonstrate a track record of growth but can also remain resilient during crises.

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Some businesses have managed to raise their dividends despite the severity of the economic damage wrought by the pandemic.

Over time, the increase in dividends will increase your flow of passive income.

3. The gift that keeps giving

And here is where the magic begins.

As you begin to receive more dividends, you now have the opportunity and flexibility to plough some of this money back into your stock portfolio.

Combined with any spare cash you may have, you can then scoop up even more shares of these resilient, dividend-paying businesses.

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With higher share ownership in these successful businesses, you will be enabling more dividends to flow into your bank account over time.

The process of using your dividends to generate ever-higher levels of dividends is known as compounding, and Albert Einstein was said to remark that “compounding is the eighth wonder of the world”.

Like a gift that keeps giving, this flow of dividends will continue even as you go about your daily life, and without any effort on your part.

By rolling over your dividends back into the very same stocks that paid out those dividends, you are in effect making your money work harder for you.

This is opposed to leaving the same amount sitting idly in a bank account, where it will surely get eroded by inflation.

If you add on the fact that the dividends from such companies are also rising as you reinvest the dividends you receive, it’s akin to receiving a double bonus.

Get smart: A roadmap for success

So, the secret to generating a flow of dividend income is out, and it’s not that tough to understand or implement.

There is a clear and defined roadmap for success – simply invest in dividend-paying companies, reinvest the dividends you receive, and hold onto these businesses over the long-term.

It’s simple, yet effective.

However, you need to remember that the ride may get bumpy.

Volatility in stock markets and dips in the economy will impact share prices, and these may fluctuate wildly based on prevailing sentiment, too.

The path may be clear, you will need patience and fortitude to stay true to your goals.

As long as you do not stray from the path, you will be rewarded with greater wealth over the long-term.

This article was first published in The Smart Investor. Disclaimer: Royston Yang does not own shares in any of the companies mentioned.