I may not be a parent, but the idea isn't lost on me that parents want nothing more than to see their children be successful. They want happiness, health, and wealth for their kids that's on par if not better than their own.
Unfortunately, parents don't have a magic wand that can grant perfect health and happiness for their kids. Wealth, however, is where parents do have the ability to exert some degree of control over their children's future.
Time is your ally
You see, time is the greatest ally an investor has to work with. By seeking out quality companies, investors have the ability to compound their gains through the use of dividend reinvestments. Most high-quality businesses pay a dividend, and a good portion of investors pocket this payment and go on with their lives.
However, reinvesting this dividend (i.e., buying more shares of stock with the money received from dividend payments) can really accelerate your growth, as more shares owned yield bigger dividend payments, which in turn can lead to even more shares purchased. It's a repeating pattern that could set your kids up for a comfortable retirement.
Let's use a real-world example to illustrate how powerful of a tool compounding can be, and then look at three stocks you can consider buying for your kids that could set them on the path to a great retirement.
The power of compounding
Imagine that you invest $10,000 into a fictitious stock with a 3% dividend yield for your child in 2015. If we use the average historical return for the stock market of 8% as our annual growth rate, then your child should have a little less than $25,000 without dividend reinvestment in 2025, around $110,000 in 2045, and by the time she retires in 2065, that original $10,000 would be worth $484,000. This assumption also includes no dividend growth, which is probably unlikely if you're picking out a high-quality business. Either way, it's an impressive return.
Now, let's imagine this same scenario with a twist. In this scenario, our investor is going to reinvest his dividends back into our fictitious stock with the 3% dividend yield. We're also still going to assume that the stock market appreciates at 8% annually, just like in our previous example. After 10 years, the difference is pretty marginal, with our reinvestment investor slightly outpacing with a little over $26,000.
But, 30 years later, our reinvestment investor has nearly $141,000, a $31,000 improvement over our investor who didn't reinvest his dividends. By year 2065, our dividend reinvestment investor would have a cool $675,000, or $191,000 more than our "pocket the money" investor.
This the power of compounding in action. It might seem like a utopian example, but the reality is you can do this! Even at a 6% annual stock market return, the dividend reinvestment investor would outpace the non-reinvestment investor by more than $95,000 after 50 years. It's a powerful strategy that could lead to big gains for your children.
Three stocks to kick-start your child's retirement
Now, let's take a closer look at three stocks that could help you jump-start your children's retirement.
The first thing you're probably going to say is, "Where's Apple (AAPL -0.34%)?" or any tech or healthcare stock, for that matter. While Apple does have an incredibly strong balance sheet and has arguably changed the landscape of how we communicate over the past decade, technology trends are incredibly tough to predict over a 50-year period. The same can be said for medicines and medical devices, which are constantly being researched and replaced. It also doesn't help that drugs have finite patent periods.
Taking that into consideration, I wanted business models as close to timeless as possible. That led me to three companies.
1. Kinder Morgan (KMI -1.80%)
Kinder Morgan probably isn't a household name, but it's a critical behind-the-scenes player in the energy infrastructure industry. As North America's largest energy infrastructure company, it's responsible for transporting and storing a sizable chunk of the oil and natural gas that U.S. shale companies recover. In other words, it's an energy middleman, or midstream company, that delivers oil and natural gas from producers to refiners.
What makes Kinder Morgan so special is twofold. First, energy demand is expected to rise over time. It's a function of an ever-growing global population as well as an industrializing world. As nations like China and India begin to expand their own infrastructure, their need for fossil fuels will rise. Higher energy demand is great news for a company that handles transmission, storage, and terminals.
Secondly, Kinder Morgan locks in its contracts for the long term. This means it has limited exposure to wild fluctuations in commodity prices like oil and natural gas. It also means shareholders can count on predictable quarterly cash flow.
All told, Kinder Morgan is currently paying a very respectable 4.3% dividend yield that's anticipated to grow substantially in the years to come.
Aflac, which provides supplemental income insurance and currently derives about three-quarters of its business from Japan, has a pretty seamless business model, as does most of the insurance sector. Insurers survive by charging a monthly or annual premium to protect a policyholder against the potential for a disaster. In Aflac's case, it helps supplement income in case a policyholder gets hurt and misses work. In return, Aflac and other insurers hope that what they pay out in claims is lower than what they've brought in through premiums.
Most insurers have substantial cash reserves saved up in anticipation of catastrophes, which can cause a bump-up in claim payouts. Insurers usually invest these large cash sums in safe time deposits like CDs or investment-grade bonds to generate investment income.
But, what makes the insurance model perfect to hold over the long run is its pricing power. If a catastrophe occurs, an insurer can simply use the catastrophe as justification for raising its premium prices. In other words, it needs to replenish its reserves. But, even when claim payouts are below normal, insurers can raise premium prices with the intent of "getting ahead" of the next catastrophe.
This business model has led Aflac to 32 consecutive years of dividend increases and a current yield of 2.5%.
The idea here is simple: As the population of the U.S. continues to grow, our consumption is also likely to grow, leading to more trash and potentially more recyclables. Waste Management, through its innovations, has discovered multiple pathways to generate revenue including trash collection, recycling, and landfill-to-gas energy facilities.
Because trash collection is a necessary service, Waste Management holds incredible pricing power over this aspect of its business. It can ensure that it's always matching or outpacing inflation this way. Furthermore, its recycling business can help offset its expenses, ultimately boosting its profits and margins.
While not in the Dividend Aristocrat category just yet, Waste Management announced with its fourth-quarter earnings results that it had increased its dividend for the 12th consecutive year. Currently, Waste Management is paying an S&P 500-topping 2.9% yield.
The ball is in your court
As a reminder, I don't have a crystal ball and can't guarantee these stocks will return exactly 8% per year -- or even go up at all. What I can say is these three companies have business models in place that are designed to survive the test of time, and they could be the perfect companies to consider investing in for your children. The ball is in your court now. The question is, will you act?