Benjamin Franklin is known for his words of wisdom. Some of his most famous sayings are "nothing is certain but death and taxes" and "time is money."
With respect to investing, time definitely has a direct link with money, and the magic of compounding interest over years is amazing. But the second part of the equation for wealth creation -- rate of return on investments -- is equally important.
So let's assume that, like Ben Franklin, we made the most of our time by starting to save and invest our money at an early age. The next step is to ensure that we are using all opportunities to maximize our rate of return on those investments. Even simple steps that yield modest improvements in returns can show amazing benefits.
A penny saved is a penny earned
Sometimes, we lose sight of the fact that little things can turn into very big things over extended periods of time. To illustrate, look at how small increments in rate of return can have a dramatic impact on your portfolio value:
|
Starting Value |
Rate of Return |
Value at 20 Yrs. |
Value at 25 Yrs. |
Value at 30 Yrs. |
|---|---|---|---|---|
|
$10,000 |
10% |
$67,275 |
$108,347 |
$174,494 |
|
$10,000 |
12% |
$96,463 |
$170,001 |
$299,599 |
|
$10,000 |
14% |
$137,435 |
$264,619 |
$509,502 |
Obviously, giving investments more time to grow gives a big boost to a portfolio, as we've talked about here at the Fool many times before. Yet notice how a 2-percentage-point hike in the annual rate of return is the same as cutting nearly five years off your savings timeframe. Looked at another way, boosting your returns that little bit could help you retire almost five years sooner.
Beware of little expenses
Many investors believe the secret to boosting the rate of return on their portfolio lies in better stock picking. But there are actually more predictable, proven methods to boost your returns. Here's just a few for consideration:
1.
Invest in high-yield stocks
In his latest book, The Future for Investors, Jeremy Siegel concludes that companies paying generous dividends over long periods of time significantly outperformed the market average, so long as shareholders reinvested those dividends. In fact, various portfolio strategies that included historically high-yielding companies such as Altria Group (NYSE:MO), Coca-Cola (NYSE:KO), and Wrigley (NYSE:WWY) beat the market average by as much as four percentage points annually. The positive effect of dividend reinvestments (over time periods when the stock dips) contributes to what Siegel terms "the return accelerator." Indeed, achieving a four-percentage-point boost in rate of return over 20 years will double the size of your portfolio.
2.
Avoid short-term trading
While online brokerages have dramatically reduced fees for stock trades in recent years, frequent trading can kill returns in a number of ways. First, taxes on short term trades take a bigger bite out of gains when you don't hold stocks beyond one year. Additionally, attempts to time the lows and highs of stocks usually backfire.
And since dividends reward you the same regardless of market performance (Garmin (NASDAQ:GRMN), for example, was going to pay out $0.50 in 2005, no matter where it was trading), it's easier to let your dividend winners run.
3.
Use effective tax planning methods
Though Uncle Sam stipulates that we all have to pay tax, he gives us plenty of options for when and how much to pay. Well-planned tax strategies can make a significant difference in the rate of return on your investments. For instance, differences in tax rates applied to gains on stocks you've held for different periods or acquired at different cost bases may significantly influence adjustments made to your portfolio. For example, if you needed to sell your holdings in Apple Computer (NASDAQ:AAPL) that you've gained 50% on this year, you might opt to liquidate another stock in your portfolio that has lost a similar amount, such as Dell (NASDAQ:DELL), to reduce your net gains and avoid the taxes. Generally, it's not a good idea to base buys and sells on taxes alone, but slight shifts in timing of exactly when you do the buying and selling could be profound.
Additionally, the Jobs & Growth Tax Relief Reconciliation Act of 2003 reduced the tax rate on qualifying dividends in most cases to 15%. Again, this makes dividend-paying stocks an attractive means to boost returns.
The Foolish bottom line
Together, these strategies can help you squeeze the most out of your portfolio and maximize your retirement dollars. If you'd like to learn more about the rewards of dividends, consider joining our Motley Fool Income Investor service. It's aimed squarely at helping investors achieve the best long-term returns. In addition to two researched stock picks per month, head income investing guru Mathew Emmert regularly dispenses lucrative advice and tips on investing strategies that employ dividends. Here's the best tip, though -- a 30-day trial to the service is free by clicking here.
Fool contributor Dave Mock tries to adhere to Ben Franklin's quote: "Either write something worth reading or do something worth writing." He owns shares of Coca-Cola, Wrigley, and Garmin. A longtime Fool, he is also author of The Qualcomm Equation .
Coca-Cola and Dell are Inside Value picks. Wrigley is an Income Investor pick.UnitedHealth Group, Dell, and Garmin are Stock Advisor picks. This information is brought to you by the Fool's disclosure policy.
