HDV - Don't Buy Coffee Put $5 A Day In HDV Instead

2023-05-23 15:21:28 ET

Summary

• Many Americans spend about $5 per day on coffee.
• While this seems like a small amount, investing $5 a day in a good dividend fund can have a snowball effect.
• In this article, we are testing this on HDV.

As a nation, we love coffee and many people buy coffee every single day, spending about $4-6 dollars per day on this habit. How would this money and its dividend income would grow if this money was instead put into an investment account and invested into a high dividend ETF with dividend reinvestments turned on, such as iShares Core High Dividend ETF ( HDV )?

Overview of the fund

Before we back-test this, let me offer an overview of HDV. This is a BlackRock fund that's been around for a little over a decade (13 years to be exact) and the fund tries to find dividend companies that not only pay higher than average yield but also have a history of raising dividends over years. As a result of this approach, the fund itself also has a history of raising dividends year after year since its inception, with only a couple exceptions and those were due to some shifts in the fund's portfolio.

One thing I hate seeing in high yielding dividend funds is a NAV erosion. Many times you see a fund lose value year after year paying high dividend yields and the stock price drops at a larger rate than dividends grow, which causes investors to lose money. This could be due to funds buying too many yield traps, funds being overleveraged, funds using wrong strategies or simply bad luck. Luckily, this fund as an ETF has a history of not only paying high yields and raising dividends but also a history of share price appreciation over time which reflects very positively on investors' total returns.

The fund invests in 10 different industries ranging from healthcare (more specifically pharmaceuticals) to utilities, with the weighting of each industry ranging from 1% to 25%. Some of the fund's positions are well-known dividend kings such as Johnson & Johnson (JNJ), Coca-Cola (KO) and AbbVie (ABBV). The fund is also overweight in big oil stocks such as Chevron (CVX) and Exxon (XOM) and has some exposure to dividend paying technology stocks such as Cisco (CSCO) and IBM (IBM). It seems to have all its bases covered.

The fund has a very small expense ratio of 0.08% because it's not actively managed. Once the list of dividend winners are established, this list rarely changes anyways, so there is very little need for making adjustments.

The fund's holdings have a combined P/E ratio of 12.33 which is roughly half of the current P/E ratio of the S&P 500 which is 24 not to mention the Nasdaq's average P/E of 30. It's even cheaper than the Dow Industrial index, which has a lower average P/E than other indices at 20. This should provide you with some margin of safety if we enter a recession and the market experiences volatility. Historically, stocks with low P/Es and high dividend yields tend to hold on better during rough times as compared to high-flyers with little to no dividend.

Back-testing $5 a day theory

Our back-testing starts with investing $5 in this fund on the day it was launched, and then investing $5 a day every single weekday until now. This would mean investing about $110 a month regardless of season, week, month, year, bull market, bear market or any other variables. Our assumption also assumes no transaction costs, since many brokers now offer free trading for buying and selling shares. Basically, when you invest a fixed amount every single day, you will end up buying more shares on down days, less shares on up days and your average purchase price will more likely to be in a favorable position due to the power of dollar cost averaging.

Below is how our $5 a day invested into HDV would grow over the years. As you can see, we are seeing a steady increase in our account size over the years, when even the biggest market plunges look like a tiny dip in the chart. For example, during the March 2020 crash our portfolio size dropped from $18k to $13k but quickly recovered back to $18k before the year was over and then some more in the following year because (hypothetically) we were able to reinvest dividends at cheap prices and kept adding those daily $5s into our account. As of this month, the account grew to a size of $27k and still growing. So far, we've invested $15k into this account, so our money almost doubled in the process.

Then, how did our dividends grow over time? After all, this is a high-yield dividend account and our goal was to grow our income through rising dividends and take advantage of the "snowball effect". Through adding more funds, dividend reinvestments and organic hikes in dividends, our income should be growing year after year at a healthy rate. Let's view the results.

As you can see below, our dividend income kept growing year after year without exceptions. In our first year we were only able to generate $11 in dividends, but in our second year it grew to $67. By the fifth year, our dividend grew to $275 per year and last year it passed $913.

Think about this, we started our journey by investing $5 a day and now our dividend income snowballed to almost $3 a day. In a few years, we will generate more income per day than we are actually investing per day, so our dividends will be able to provide us with free coffee every day for the rest of our lives.

Earlier I said we would invest $5 per weekday, but what if we were a bit more aggressive and decided to invest $5 per day ($35 per week) and increased our contributions over time at the rate of inflation. By making these two small adjustments, now we were able to grow our portfolio size to $40k instead of $27k with the previous strategy.

How about our dividend income with the new strategy? Now we are seeing our annual dividend income snowballing to almost $1400 which is $3.75 per day. In a couple of years, we will pass $5 in daily dividend income, so we will generate more in dividend income than we are putting in every day.

While these numbers don't look very large, it shows you the effects of snowballing in just a little over a decade. If you kept doing this for 20-30 or 40 years, you'd actually be amazed with results. Assuming the same rate of results will persists, if you keep investing $5 a day for another 10 years, your $27 account will actually grow to $88k. Give it another 10 years after that, and you will reach $224k in account value and $9k in annual income. This all started with $5 a day. Now you can buy all the coffee in the world for the rest of your life.

Conclusion

I like the idea of setting aside a small amount of money that won't hurt someone's budget per day and investing it into a fund that can generate growing amounts of income forever. HDV seems like it fits the bill, and back-testing results seem to support this idea. You won't notice $5 a day missing from your wallet, but you will notice the snowball effect and gains over time, especially if you are patient enough to have a truly long-term horizon.

For further details see: