How to Turn $1,000 of Your Kid's Savings Account into $168,700
InvestorEducation / Dividends Aug 09, 2010 - 06:08 AM GMTBy: DailyWealth
Tom Dyson
writes: How would you like to turn $10,000 into $178,200 using an investment strategy that takes no work, skill... or even attention?
Even better, how does a $168,700 stake from an initial investment of $1,000 sound?
There's only one investment technique I know that's mathematically certain to build fortunes like these from small starting positions.
Not only is this technique sure, but it's also easy, cheap, and anyone can do it – even a child. I'm talking about compounding...
You invest your money in something that pays you a return in the form of dividends, interest, or profits. Then you reinvest your dividend or interest income back into the investment. Now your dividends are earning dividends and your interest is earning interest. You are "compounding" your gains by reinvesting your profits.
A snowball is the best analogy for compounding. When you first roll the ball in the snow, it gains mass slowly. But as the surface area increases, it picks up more snow. Suddenly the ball is so heavy you can't move it anymore.
Time is the most important ingredient in compounding. The more years you give it, the more your money mushrooms. Here's how it works...
Let's say at age 40, you invest $5,000 at 8% and reinvest the income. At age 65 you'll have $34,000. If you'd made the same investment at age 20, you'd have $160,000 by the time you turn 65.
Besides time, you also need a safe investment that generates a reliable return...
Blue-chip stocks are one of my favorite investments for harnessing the power of compounding. Blue chips are the giant oak trees of capitalism. They dominate their industries with powerful brand names, recession-proof products, and huge marketing budgets that keep out all other competitors.
Over the last century, buying blue-chip stocks that raise their dividends year after year has compounded your money faster than any other passive investment technique in the universe. Warren Buffett – the most successful investor in history – essentially used a blue-chip compounding strategy to return 20% a year for almost 50 years. He's now worth $50 billion.
This table shows what happens to your money if you'd invested $10,000 in Microsoft, Wal-Mart, ExxonMobil, and McDonald's on December 31, 1986, a few months before the Wall Street crash. (I could have used Johnson & Johnson, Procter & Gamble, Coca-Cola, or Phillip Morris, and the results would have been just as good.)
Reinvesting dividends, $10,000 in... |
Turned into... |
Microsoft |
$1,696,980 |
ExxonMobil |
$138,458 |
Wal-Mart |
$202,139 |
McDonald's |
$178,231 |
Start date: 12/31/1986 |
Today |
To make the most of compounding, you should make regular payments. If you'd invested $5,000 every year at 8%, starting at age 20 and reinvested the income, you'd have almost $2 million by age 65.
Direct investment plans, or DRIPs, let you do this. Many companies sell stock to the general public directly. They let you invest in their stock – and reinvest your dividends – without paying broker commissions.
More importantly, when you buy stocks using direct investment plans, you can make regular automatic investments in these stocks, every month, quarter, or year, without incurring broker fees.
If I were going to set up a blue-chip compounding portfolio right now, I'd probably start with Microsoft, Exxon, Wal-Mart, and McDonald's. These stocks will pay bigger and bigger dividends over the years to come. And they're cheaper than they've been in years. Microsoft, for example, is at the same price it was in 1998... and you can still buy Wal-Mart at 1999 prices.
All you need to do is make regular investments in these blue-chip stocks and watch your money compound into a million-dollar fortune over the next 30 years.
Good investing,
Tom
P.S. Due to the significance of time to this strategy, it's important for your kids to learn about compounding. Get them set up compounding at a young age and they'll never have to worry about money again. They might even grow to be as rich as Warren Buffett!
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