“Your actions over time can lead to significant, significant results.”
That’s what I told my YouTube viewers last week on The Wide Moat Show. It’s an obvious statement, really, but one we ignore too often… at our own financial peril.
New York University Stern School of Business Scott Galloway addressed this topic as well last year on Chris Williamson’s channel. When asked what people should “do in order to achieve financial security,” he answered with a story.
Scott apparently has a friend who makes “$3 million in a bad year” and “$14 million in a great year.” But because he lives in Connecticut, he pays about 52% of that income in taxes.
Worse yet, “between his ex-wife, his alimony, his child support, his home in the Hamptons, his master-of-the-universe lifestyle that he thinks he needs and wants to signal to his friends,” Scott knows “firsthand that he doesn’t save a lot of money. And it is an enormous source of stress for him and on his marriage.”
That only makes sense when, as I put it, actions have consequences – whether good or bad – with some being more predictable than others. If you’re throwing money on unnecessary day-to-day expenditures just to keep up with the Joneses, you’re probably going to suffer for it in the future.
Or, as with Galloway’s friend, even in the present.
The much better approach is to spend your working years living comfortably, not extravagantly. Unless brand names can truly make it worth your long-term while, don’t buy them. Find affordable ways to entertain yourself. And keep your cars however long they’ll last.
(Incidentally, my next Wide Moat Confidential pick actually benefits from tariff-increased used car prices).
Then you take a large chunk of the money you’ve saved through those actions, and you invest it in strong, safe companies that pay you dividends.
I know markets are volatile right now. The latest news this morning was that China would raise tariffs on the U.S. to 84%. Stocks opened lower. The 10-year Treasury yield briefly rose above 4.5%. Things are very disorderly right now.
With all that in mind, it may seem strange to discuss managing spending and the beauty of compounding. But in reality, it’s the ideal time.
As Stephen Hester shared on Friday, the current downturn is just one of many crises the market has experienced over the years. Each one, without exception, turned out to be a buying opportunity. With time, this one will be remembered the same way.
And I hope that what I share today will help you make the most of things over the long term.
What Compound Interest Can Do to $1,000
Let’s get right to the point. The best way to invest in quality dividend stocks is twofold:
- Buy them at a discount.
- Every time they pay their dividends, reinvest that money right back into the same companies.
Fortunately, the market is taking care of Step 1 for us. Many great companies are significantly cheaper than they were just a few days ago. And my team and I plan to highlight them in the coming days and weeks.
This second step allows you to tap into the power of compound interest. It’s something I detailed way back on January 3, writing:
Understanding the concept isn’t complicated. Imagine a snowball rolling down a hill…
No matter how small it starts off, once it gains momentum, each rotation causes it to multiply in size.
This exponential growth is the most powerful force I know of in the markets.
To put it in financial terms, let’s say you start out with a $1,000 stake into a solid company that offers a 5% dividend yield, paid out quarterly. We’ll keep it simple by saying you don’t put a single cent more into that stock other than reinvesting dividends. And shares appreciate a mere 7% per year.
Under those basic taxable conditions, your initial expenditure would turn into $2,859 in 10 years. In 20, it compounds to $8,173. After 30, it becomes $23,365…
And after 45 – the average number of years an American works during their professional lifetime – it’s a whopping $112,939.
That’s a lengthy amount of time, it’s true. Then again, we’re just looking at what $1,000 plus dividends and mediocre share appreciation can do.
Think about what that number would look like if you had a $5,000 portfolio… a $10,000 portfolio… or a $50,000 portfolio. Thanks to the power of compound interest, your yearly figures more than quintuple, decuple, or quinquagintuple.
(Yes, that’s an actual word. I didn’t make it up.)
A $10,000 initial investment after 45 years would be worth more than a million dollars. Now, that’s the kind of “uple” I’m talking about.
Two Compound Interest Tips to Try
Of course, most people can’t invest that kind of money right at the onset of employment. Kids right out of college typically begin their working lives with a small salary and massive loans to pay off.
Then, as we get older, other responsibilities creep into the picture, including mortgages, children, and college funds. Plus, as Scott Galloway pointed out in that podcast, you have to “recognize that there are some things out of your control.”
So let me give you two tips on making the most of compound interest’s powers no matter what.
The first is this: Access dividend reinvestment plans, or DRIPs, wherever possible. These automatically funnel investment dividends right back into the shares they came from, ensuring that investors don’t miss a beat.
Many publicly traded companies offer them internally, though there are plenty that don’t. Fortunately, most brokerage firms provide this service as well, helping those of us who are short on time or memory.
Then there’s dollar-cost averaging – a practice that’s especially perfect during times of market weakness like we’re seeing right now. At its most fundamental definition, it’s the act of adding an extra, fixed amount of money into investments you already own at regular intervals.
The point is to limit or even reverse the effects of market volatility, giving you more room to grow. And it really can work, though I prefer a modified version of this approach.
I highly recommend against buying into any stock, no matter how successful, at overpriced valuations. I want bargains all the way.
That’s why I’ll put more money into my favorite stocks – always paying attention to portfolio diversification, mind you – only when their prices unnecessarily fall out of favor. That way, I’m getting the best bang for my buck every time I buy in.
Add those kinds of smart actions to your dividend-fueled compound interest actions, and your results can be even more significant in all the right ways.
By adopting intelligent asset allocation targets that dovetail with ownership of dividend-oriented stocks, the power of compounding can lead to strong shareholder returns that allow you to make money while you sleep.
That’s what I call sleeping well at night!
Regards,
Brad Thomas
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Source: Wide Moat Research