He was wrinkled and spoke softly, but he taught the greatest investment lesson ever told. He was John, my first finance professor.

As co-advisor for the Motley Fool Income Investor newsletter, I still consider John's lesson the best investment advice I've ever received.

What John taught can literally make you a fortune, so pay close attention. You'll also get four stocks that you may use to begin implementing it yourself.

Do you know Jack?
Our quick-but-powerful story starts with two twins: Jack and Jill.

As they turn 18, Jack takes a job out of high school and begins investing. From age 18 to 30 -- when he gets married and has his first kid -- Jack socks away five grand a year. Then he stops.

Jill, meanwhile, goes to college and then medical school. She starts saving at 30 -- the same $5,000 per year.

Both invest in the stock market, earning a long-term average of 11% a year. But by age 65, the difference in their financial fortunes will shock you:

Jill, who contributed for 35 years straight, will have $1.9 million. But Jack, who invested for only 12 years, actually has $4.9 million ... thanks to his head start!

Could you use $4.9 million for your retirement?

Ignore John's advice? Better like Alpo!
The best time to have started seriously investing will always be "years ago." I sure wish I'd started earlier. But this is reality, and if you don't want to eat canned dog food in your retirement, put the power of compounding to work for you as quickly as possible.

Fortunately, academic studies have identified the best way to do so: Dividend stocks. Let me get more specific.

Famed Wharton finance professor Jeremy Siegel -- you've likely seen him on TV or read his books -- found out something very powerful recently: From 1871-2003, a full 97% of the stock market's return came from reinvested dividends. Only 3% was from capital gains on the original principal!

The case for dividends gets stronger. Dividend stocks have a reputation for safety, but they also have a secret agenda that enriches investors. Rob Arnott, former editor of the Financial Analysts Journal, and Cliff Asness, managing principal at AQR Capital Management, uncovered it: Stocks with the highest yields actually show the highest earnings growth over the next decade. So even when you think you're looking at stodgy dividend payers like Kraft (NYSE: KFT) and Bank of America, you're unintentionally exposing yourself to fantastic capital appreciation as well.

There's more. Ned Davis Research found that from 1972 to 2006, S&P 500 stocks not paying a dividend returned 4.1% annually, while dividend payers returned 10.1%! Can you imagine the difference that six extra percent per year would mean for your retirement?

You can take dividend stocks to the bank
Why not put that kind of power to work for your own portfolio? We could all use extra money at retirement. Because I believe in practicing what I preach, I own dividend stocks myself. I also find them for subscribers of my Income Investor newsletter.

I've screened for some starting-point stocks below. I must be clear: Not all of the stocks below are my formal recommendations. Most of them are do-it-yourselfers, so consider this list a solid starting point for further research.

To find these stocks, I used Capital IQ, an institutional investment-analysis software package, to screen for stocks yielding more than 3%, with market caps greater than $1 billion (to provide stability), and with payouts less than 85% of free cash flow (more cushion means a company's better able to pay its dividend consistently). Strong operational returns are a must -- they provide a cushion against rough times, as well as fuel for the good times -- so I set a return on equity (ROE) floor of 10%.



Market Cap (mm)


Cincinnati Financial (Nasdaq: CINF)












Avery Dennison (NYSE: AVY)




Let's make you a fortune
Want to end up like Jack -- an almost-slacker turned multimillionaire at retirement? You can start with two actions:

  1. Start saving as much as humanly possible, to harness the power of compounding.
  2. Heed the findings of academics and diversify your investments to include dividend stocks -- the very best dividend stocks.

Here's why quality matters: If Jack had managed just two percentage points better returns than Jill (let's say that instead of 11% for both, Jill earns 10% and Jack earns 12%), Jack's outperformance would leave him the envy of Jill's medical-school class: $7.1 million at age 65 vs. just $1.5 million for Jill! Two little percentage points mean millions of dollars down the road.

Your next move
Dividend stocks might not seem that different now, but they can make a big difference down the road. You've got four starting points above. I'd also like to offer you a free guest pass to my Income Investor service. We've done the research to find the very best dividend payers. The service is currently besting the market by more than seven percentage points.

This article was first published Aug. 30, 2007. It has been updated.

James Early owns no securities mentioned in this article, although at one point, he sported an attractive handlebar moustache. A free trial also takes you to his photo (sans moustache). Cincinnati Financial, Kraft, and Bank of America are Income Investor recommendations. The Motley Fool has a disclosure policy.