<THE DRIP PORTFOLIO>
Discipline + Time
...leads to the desired Foolish result
by Jeff Fischer (TMFJeff)
ALEXANDRIA, VA (May 4, 1999) -- Conventional Wisdom holds that you need a pile of cash before you can begin to invest successfully in stocks. Investing via direct investment plans turns that notion on its head and proves the opposite can be true. Whether you have $100 or $100,000, what's most important is when you start to invest and how you invest. A Fool beginning with $100 can be in a better position to succeed than a Wise man with $100,000.
How can this be?
Because discipline, time, and compounding are the three main contributors to successful investing -- not the amount of money that you have to invest.
A new investor possessing little money to start, the right discipline (which so many investors lack), and more than a few years to be invested (ideally a decade or longer) can use compounding to build a nest egg that tops "big-money" investors' results. The first necessary asset is discipline. How do you acquire it? Many investors are their own worst enemies, lacking a helpful, consistent discipline.
Enter: a solution.
Direct investment plans provide a framework for a successful investing discipline. Discipline includes staying invested at all times, not trading actively, and -- for most investors -- consistently saving and buying more shares. Direct investing supports all of these activities. The plans are not incredibly easy to sell from, so it is rare that you make a snap decision to dump stock when the market tumbles. Instead, your mentality usually becomes: "Great! I'll buy more shares this month because prices are lower."
Next, if you make automatic electronic investments through your bank every month -- as many companies allow -- you are essentially on "auto pilot to success" without even thinking about it as long as you invest in strong stocks. If you send a check in the mail each month instead, as we do, you merely need to discipline yourself to do so each month. Fools on our Drip boards find this easy: they become addicted to monthly investing and they enjoy watching their stock accounts grow.
Discipline with stocks includes buying, holding, and saving, and buying more when you can. Direct investing is optimal.
As measured by the S&P 500 index, the stock market has risen 11% annually, on average, with dividends reinvested, since 1926. This compares to the 2.5% to 3% yield that a savings account typically yields today. The stock market has been the best-yielding investment available over its history, yet thousands of people have lost money on it. Why? Because it is time that awards you the high returns. The stock market declines many years. It cannot be predicted, however, and trying to do so is costly. Studies show that a majority of the stock market's gains take place during a condensed period -- over a number of combined weeks each year. If an investor misses those weeks, her results suffer. An investor needs to stay invested, and history demonstrates the longer the better.
The sooner that you can begin to invest (after your credit card debt is paid) and the longer that you can stay invested, the more likely it is that you'll be significantly rewarded. If you invest just $3,000 in a handful of successful companies that return 12% annually and you hold for 20 years, your money would grow to nearly $29,000 -- almost ten times in value in 20 years. If you hold for another 10 years, you'd have nearly $90,000. When you couple the power of a good investment discipline with time, you get a one-two punch. Discipline combined with time results in the desired Foolish outcome: compounding.
To compound your money is to build wealth on top of newly built wealth, as well as on top of your original investment. If you start with $1,000 and earn 10% in year one, you'll earn $100 and have $1,100. If you earn 10% again in year two, you'll earn $110, not just $100, because your investment base has grown. The following year, another 10% gain will represent an even larger dollar amount earned. Compounding is simple math that we learned in fifth grade, but it was probably too promptly forgotten.
Discipline + Time = Compounding
When you combine the three criteria necessary to build wealth, you get the equation that headlines this paragraph: Discipline + Time = Compounding. In the end, compounding is the goal. Write the equation down (D+T=C) and tape it to your computer screen if you actively watch stocks online.
The following tables demonstrate the power of our equation.
The first table assumes that an investor begins with $500 in various direct investment plans and adds $100 per month to his investments (as the Drip Port does). The table demonstrates how his money grows over 5, 10, 15, 20, 30, and 40 years at annual appreciation rates of 7%, 11%, and 15%. The second table shows an investor who begins with $1,000 and adds $200 a month to her investments. We'll consider the same percentage returns for her.
Fool #1 began with $500 and added $100 monthly (like Drip Port). Total amount invested at the end of 20 years: $24,500. After 40 years: $48,500.
Value when growing: 7% 11% 15% Year 1 $1,745 $1,820 $1,866 Year 5 7,868 8,816 9,911 Year 10 18,313 23,194 29,741 Year 15 33,120 48,052 71,528 Year 20 54,112 91,031 159,581* Year 30 126,055 293,806 736,098 Year 40 270,637 899,929 3,295,955
*Drip Port's goal, $150,000 in 20 years.
Fool # 2 began with $1,000 and added $200 monthly. Total amount invested at the end of 20 years: $49,000. After 40 years: $97,000.
Value when growing: 7% 11% 15% Year 1 $3,550 $3,640 $3,732 Year 5 15,736 17,632 19,822 Year 10 36,626 46,388 59,483 Year 15 66,241 96,105 143,057 Year 20 108,224 182,062 319,163 Year 30 252,110 587,612 1,472,196 Year 40 541,274 1,799,589 6,591,911
When the first Fool achieved the stock market's average 11% annual return, his portfolio grew to $91,301 in 20 years. But remember that a full quarter of his money was invested only during the last 5 years, giving it less time to appreciate. If he can let his money appreciate 10 more years, without adding an additional cent, he'd end with $259,241. If he keeps adding $100 every month, he ends year 30 with over $293,000. (Keep saving and investing, Fools!) That's after beginning with $500 and adding only $100 a month for 30 years, or $36,000. Imagine if he had invested a little more each month -- say $200. Either way, it's year 40 that really shows results: he has nearly $900,000.
Fool #2 began by investing $1,000 in a handful of direct investment plans (she choose companies such as Coca-Cola and Johnson & Johnson), and then she added $200 a month for 40 years, resulting in a total investment of $97,000. After 20 years of achieving the stock market's average 11% annual return, her investments grew to $182,062. If she earns a slightly better return of 15% annually (as she could have with Coke and Johnson & Johnson), she'd have $319,163 after 20 years.
What would her portfolio grow to become in 10 more years growing at just 11%, even if she didn't add another nickel? Easily in time for retirement, her basket of stocks would exceed $905,775 in value. And in that example, she only invested a total of $49,000 over 20 years, or about $2,400 per year. Look at the chart to see the results if she'd continued to add more money each year. Year 30 finds her a millionaire (worth $1.4 million) if she earns 15% annually. That's after investing only $72,000 over 30 years ($200 a month), plus her $1,000 seed money.
There are two important lessons to take away from these tables:
1) time matters greatly
2) your annual return matters greatly
In the examples above, most of the value is created in years 20, 30, and 40 -- and each decade represents much larger absolute dollar growth than the prior decade. If we carry the examples out further, a great deal more value (again, most of the value) would be created in still later years. That's how compounding works. Most value is created at the tail-end of an investment's life. Always keep that in mind as you embark upon, and continue, your investment career.
You can also see from both tables that the annual return an investor achieves means a great deal. Every percentage point is significant, especially over long periods of compounding. That's part of the reason why it is so important that you learn to manage your money Foolishly and avoid mediocre companies. That's not always easy, given all of the unforeseen events in this world, but if a majority of your investments are successful, you should be proud and you should reach your goals. Hopefully the main thing that you'll have, while you invest and after your investment career seems fulfilled, is happiness.
To discuss direct investing, please join us on the Drip Companies or Drip Basics board.
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