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.
That's the best advice I can give to a new investor, but it's hard advice to follow. First, $100,000 is not the kind of money folks have just lying around. I know I don't. Second, which stocks would you put it in if you did? There are nearly 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 Siegel's Constant -- and as Siegel told the Fool, 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. 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 3.9%). That meant investors could reinvest their dividends at lower prices, thereby supercharging returns.
And the rest of Siegel's S&P best are a who's who of dividend growers:
|
Company
|
Annual Return (1957-2003)
|
Current Yield
|
|
Altria
|
19.8%
|
5.2%
|
|
Kroger (NYSE: KR)
|
14.4%
|
1.3%
|
|
Procter & Gamble (NYSE: PG)
|
14.3%
|
2.4%
|
|
Hershey (NYSE: HSY)
|
14.2%
|
3.1%
|
|
Wyeth (NYSE: WYE)
|
14.0%
|
2.5%
|
|
Motorola (NYSE: MOT)
|
13.0%
|
2.2%
|
|
BorgWarner (NYSE: BWA)
|
12.8%
|
0.9%
|
|
Deere (NYSE: DE)
|
12.8%
|
1.4%
|
While all of these companies have offered solid returns to investors, the best of the bunch is clearly Altria, which not coincidentally has almost always offered one of the highest yields. As I said before, the key to its incredible return was dividend reinvestment.
The Foolish bottom line
The answer to the "Which stocks?" question for many new investors, then, is easy: companies with above-average yields and below-average prices. Those are exactly the types of companies that Fool dividend gurus James Early and Andy Cross focus on in their Income Investor service. To see some of their best ideas, click here to grab a 30-day guest pass to 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 their only investing regret is not having started sooner.
This article was originally published Feb. 10, 2006. It has been updated.
Tim Hanson
does not own shares of any company mentioned. BorgWarner is a Stock Advisor recommendation. No Fool is too cool for disclosure.
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