In my last article, I explained the importance of establishing an investing strategy and sticking with it. Buying and selling undermines your chances for success. You’ll pay fees and taxes and your efforts to gain on the trades are likely to fail. What’s more, those fees and taxes reduce the amounts that could be compounding within your account.
Albert Einstein called compound interest the “eighth wonder of the world” because of its wealth-building power. In this article, I’ll demonstrate how your money grows exponentially when you have time to allow compounding to work for you.
The question then is, how do you get the largest average annual rate of return to compound over the long term? The answer is in a broadly diversified portfolio of stocks. But setting up a stock portfolio in volatile markets can require more risk than many people are willing to take.
Our best idea is to invest in a portfolio of high-quality companies based on a dollar-cost averaging strategy. By that I mean that you would start out with a small position in each company and build up holdings over time by investing the same dollar amount on a regular basis—regardless of the stock’s market price.
That way, not only won’t you risk buying in at what might turn out to be the wrong time but you will be buying more shares when prices are relatively low and fewer shares when they are high. Your average cost will be even less than the stock’s average market price during that period.
Which companies belong in such a long-term portfolio? Look for companies that are providing products and services that you rely on. Many of these will be well-known dividend-paying companies with long records of raising their dividends on a regular basis. Investing in such companies and allowing your gains to compound over the long term has proven to be the most reliable way to accumulate great wealth.
To illustrate the seemingly magical way compounding works: Say you are 20 years old and you can find $10,000 to invest and that you can commit to investing $200 a month for the next 10 years…your total investment of $34,000 would grow to $1,913,832 by the time you reach 65 years of age.
Say you can leave your holdings in place for another five years—until you reach 70 years of age—your assets would grow to $3,082,246!
You can expect your $34,000 to grow by more than $1 million during those five years!
Not everyone can start at age 20. Let’s say you invest at age 30 and leave your money until your reach age 70, your $34,000 investment would grow to $1,186,769.
Those results are impressive, but to give you an idea of how valuable “time” really is: consider how much that $34,000 would accrue if you invested it for your grandchild at birth or when he or she is five years old.
Assuming the same investing schedule, which is $10,000 to start and $2,400 a year for the next 10 years.
In the first instance (where you begin at birth), by the time he or she reaches 65 years of age it would have grown to $12,858,246 and in the second instance (where you begin at age five) it would have grown to $7,938,959.
In fact, if you start that early, even if you can afford to put away only $10,000 and invest nothing more, your child will likely have more than $5,291,444 by the time he or she reaches 65 years of age!
Our assumptions were based on a 10% average annual rate of return over the long term, which is less than the amount actually achieved by the market as a whole since 1926. Your portfolio may do better or worse than that.
What’s critical though is that you don’t allow fees to diminish your returns and that you have the emotional stamina to stay with your predetermined strategy even when share price are falling.
Dividend reinvestment plan (DRIP) investing can help achieve those goals on many levels. DRIPs make it easy to make regular dollar amount investments to build holdings at a variety of price points. They also offer the advantage of making trading not so simple.
You can’t just click a link and sell. That’s a tremendous advantage! It’s not easy to hold on when you see market values falling. But those who succeed in holding for the long term will benefit while those who succumb to the emotions of the marketplace will lose.
Many top-rated U.S. companies offer a DRIP. And many DRIPs are offered by solid household names that don’t charge fees for investing and reinvesting dividends and have been reliably rewarding investors with dividends for decades.
Many top-rated U.S. companies offer a DRIP. And many DRIPs are offered by solid household names that don’t charge fees for investing and reinvesting dividends and have been reliably rewarding investors with dividends for decades. These include industry leaders Aflac Inc. (AFL), ExxonMobil (XOM), Johnson & Johnson (JNJ), Genuine Parts Co. (GPC), Hormel Foods Corp. (HRL), Nucor Corp. (NUE), Duke Energy (DUK), 3M (MMM) and Abbott Labs (ABT).
These companies are just a few of the hundreds that offer no-fee DRIPs. Visit this link on our website to see a full listing of “No Fee DRIPs”.
Our best advice, the sooner you start preparing for a comfortable retirement the better.
Until Next Time,
Ms. Vita Nelson is one of the earliest proponents of Dividend Reinvestment Plans (DRIPs) and a knowledgeable authority on the operations of these plans. She provides financial information centered around DRIP investing She is the Editor and Publisher of Moneypaper’s Guide to Direct Investment Plans, Chairman of the Board of Temper of the Times Investor Service, Inc. (a DRIP enrollment service), and co-manager of the MP 63 Fund (DRIPX).