Put $100,000 into undervalued, dividend-paying stocks today. Through a combination of capital gains and reinvested yields, the market could turn that single lump sum into a $1 million fortune over the next 15 to 20 years.
While that's solid advice for any new investor, it can be hard advice to follow. First, $100,000 is not the kind of money most folks just have lying around. I know I don't. Second, which stocks would you put it in if you did? There are more than 3,000 dividend payers trading on the U.S. markets alone, and there's no way to tell at a glance which are good buys.
The good news is that we can work around these limitations.
Invest more
There are fewer barriers to investing today than ever before. Opinions on stocks are a dime a dozen online, and discount brokerages make it possible to buy and sell shares for as little as a few dollars from the comfort of our own homes.
Those are wonderful developments for individuals who seek to build a secure financial future. You don't need $100,000 to start investing. You can start with as little as $350 -- the amount needed to keep commissions at 2% on a $7 trade. What kind of returns can you expect from such a small investment?
Good ones.
Constant consistency
Wharton finance professor Jeremy Siegel has demonstrated that it's reasonable to expect a real return of approximately 6.5%. That's what's known as Siegel's constant -- and as he told the Fool last year, he's pretty proud to have a constant named after him. Add inflation to that 6.5%, and you're looking at a nominal return of approximately 9%. Using the nominal rate, the stock market could deliver you a tidy $400,000 nest egg after 25 years of investing $350 each month. Not bad for only $105,000 of principal.
High yields and low prices
The key to earning that return -- as Siegel points out in his research -- is reinvesting dividends. And the power of those dividends can be profound.
According to Siegel, the best-performing stock of the original S&P 500, which began in 1957, is Altria and its incredible 19.8% annualized return. Why has it done so well? Reinvested dividends.
Investor distaste for tobacco and fear of lawsuits has kept Altria's price depressed while the company continued to pay out huge amounts of cash -- the yield today is 4.1%. That meant investors could reinvest their dividends at lower prices, thereby supercharging returns.
And the rest of Siegel's S&P best is a Who's Who of dividend growers:
|
Company |
Annual Return, |
Current |
|---|---|---|
|
Altria |
19.8% |
4.1% |
|
Abbott Labs |
16.5% |
2.6% |
|
Bristol-Myers |
16.4% |
5.4% |
|
Tootsie Roll |
16.1% |
1.3% |
|
Pfizer |
16% |
5.7% |
|
Coca-Cola |
16% |
2.6% |
|
Merck |
16% |
3.3% |
Today, all of these companies continue to boast solid yields, yet they're not without uncertainty. Former Motley Fool Income Investor recommendation Merck, for example, has a heightened risk profile, given the threat of Vioxx litigation. Of course, for long-term investors, that could be great news. If the price drops again, it means they can buy more shares with their reinvested dividends at a great price and, according to Siegel, supercharge returns.
The Foolish bottom line
The answer to the "Which stocks?" question, then, is easy: companies with above-average yields and below-average prices. Those are exactly the types of companies that our Fool dividend gurus James Early and Andy Cross focus on in their Income Investor advisory service. To see some of their best ideas, click here to take a 30-day free trial of Income Investor. There is no obligation to subscribe.
And if you're not in the market at all, consider getting started -- even with only a few hundred dollars. Great investors like Warren Buffett have said that their only investing regret is not having started sooner.
This article was originally published on Feb. 10, 2006. It has been updated.
Tim Hanson does not own shares of any company mentioned. Pfizer and Coca-Cola are Inside Value recommendations. No Fool is too cool for disclosure, not even Tim.
