How to Become a Dividend Millionaire

Dividend stocks can be powerful investments, especially over many years. Over the last 50 years, companies in the S&P 500 that pay dividends have delivered an average annual total return of 9.2%, according to data from Ned Davis Research and Hartford Funds. That's over twice what non-dividend payers delivered (4.3% per year). To put that return into perspective, a person would have needed to invest only $12,500 in dividend stocks 50 years ago to become a millionaire today.

Anyone can work toward becoming a millionaire by investing in dividend stocks. It just takes patience and choosing the right types of stocks. Here are some tips for building a $1 million dividend portfolio.

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Dividend growth trumps yield

Many beginning dividend investors make one common mistake. They put too much emphasis on a company's dividend yield -- the annual dividend payment divided by the stock price -- thinking that a higher yield will yield a higher total return. Quite often, those higher-yielding payouts lead to lower total returns, especially for companies that can't sustain their dividend over the long term.

Instead, you should focus on whether a company can steadily increase its dividend payment because dividend growers have historically delivered the highest returns:

Data source: Ned Davis Research and Hartford Funds.

As the data shows, companies that regularly grow or start paying dividends tend to deliver the best returns for investors. They beat companies that keep dividends the same or cut them -- outcomes often found with higher-yielding stocks.

The higher returns of dividend growth stocks could help you reach $1 million a little faster. For example, at a 10.2% average annual return, you can grow a $12,500 starting investment to $1 million in under 46 years.

How to find the best dividend growth stocks

Many companies are proven dividend growers. For example, Dividend Kings have increased their dividend every year for at least the past half-century, while many others have delivered decades of consistent dividend growth.

These durable dividend growers all typically have four common characteristics:

• Resilient cash flows: Companies need steady cash flows to sustain their dividends during downturns. This can come from regulated rate structures, recurring revenues, or stable demand.
• A conservative payout ratio: Most companies should pay out only 30%-50% of their income, or up to 75% in highly durable industries, to ensure they can sustain their dividends and retain enough cash to grow their business.
• Strong balance sheet: Dividend growers usually have solid, investment-grade bond ratings, which give them greater flexibility to grow and maintain their dividends during tough times.
• Operate in growth industries: Companies should be in sectors benefiting from long-term growth trends, not in dying industries.

How to build a $1 million dividend stock portfolio

You should look to build a diversified portfolio of 10 to 25 proven dividend growers with those four crucial characteristics. Ideally, you should buy companies that have delivered at least a decade of annual dividend increases. Another good target is companies that have grown their dividends by at least a mid-single-digit annual rate over the past five years. You should also hold companies across several industries, as this diversification will help reduce risk.

Individual stock picking isn't for everyone. A good alternative option is to invest in an exchange-traded fund (ETF) focused on high-quality dividend stocks. For example, the Schwab U.S. Dividend Equity ETF (NYSEMKT: SCHD) holds 100 top dividend stocks. It tracks an index that screens companies based on four dividend quality characteristics, including their five-year dividend growth rate. At its last annual reconstitution this past March, its 100 holdings had increased dividends at an average annual rate of 8.4% over the past five years. The Schwab U.S. Dividend Equity ETF's focus on dividend growth stocks has paid off over the long term. The fund has delivered a 12.4% average annual return since its inception in 2011.

Get rich slowly on dividend stocks

Investing in dividend stocks is a proven wealth growth strategy. While they won't make you rich overnight, they can slowly enable you to become a millionaire. The key is investing in the right dividend stocks, as steady dividend growers have delivered the best long-term returns.

Matt DiLallo has positions in Schwab U.S. Dividend Equity ETF. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.