The wealth-building power of compound interest will never cease to amaze me.
It's a story of patience and attention to detail, where small differences in the short term add up to massive divergence over decades. In the end, the biggest winners don't always deliver the fattest share-price returns.
Let's look at a well-known example. Home improvement retailer Home Depot (NYSE: HD ) has been a fairly close proxy for the Dow Jones Industrial Average (INDEX: ^DJI ) over the years. An improving housing market has put some spring into Home Depot's step in 2012, and the stock has raced to new highs:
So far, so great. Home Depot beats its Dow peers in the long run and has absolutely crushed smaller rival Lowe's (NYSE: LOW ) , too. But you know what? You ain't seen nothin' yet. The plain share-price returns can't hold a halogen torch to reinvesting Home Depot's modest dividends along the way.
A generous 137% return suddenly turns into a fantastic 184% payout over 10 years, and all you have to do is set up an automatic DRIP plan. It's the easy way to juicing your wealth.
The stock's dividend yield may not look all that generous today, mainly due to the skyrocketing share prices. But Home Depot has a healthy habit of increasing the payouts whenever possible. Yields spiked in the mid-2000s, then the company took a break as the housing crisis unfolded. Now the company is back to annual increases.
But the homebuilders slashed their dividends in 2008 because they never had a plan B. They haven't increased their payouts since 2007. Home Depot weathered that storm unscathed and will almost certainly survive the next one as well. Could you say the same about Lennar? Didn't think so.
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