Compound Interest Is Where the Magic Happens
Everyone wants magic to happen with their money! Albert Einstein called compound interest the eighth wonder of the world. It’s essentially interest that’s producing interest, and dividend-paying stocks are almost a perfect example of this. If you own 100 shares of Exxon stock, and Exxon stock is currently yielding you roughly a 6% dividend, that means if you never put another penny into Exxon stock, if you sit there and do nothing, this time next year, you won’t own 100 shares. You’ll have 106 shares. Do that the next year, and now you’re getting 6% on 106, so now you’re going to have 112.5.
The following year is the same, and that number continues to snowball. You’re getting a raise every year and consistently higher dividend payouts because you own more shares of stock. It doesn’t take that long until your 100 shares grows to 200 shares. Suddenly, you wake up one day later in life and have a thousand shares. That’s compound interest.
Warren Buffet and his business partner of 60 years, Charlie Munger, built Berkshire Hathaway, which is one of the largest companies in the world today. Buffet and Munger are classic Value investors and arguably the most successful investors of all time, the G.O.A.T., if you will. I have studied and appreciated them since day one, and a lot of what I practice today with the Dividend Lifestyle was a result of their influence. Berkshire Hathaway is a holding company invested in many companies. *They fully own 100% of Geiko, Fruit of the Loom, Duracell and Dairy Queen, to name just a few. Berkshire also is the largest shareholder of some of the biggest stocks in the S&P500. For example, they own 27% of Kraft Heinz, 18.8% of American Express, 12% of Bank of America, 10% of Coca-Cola, and 6% of Apple. We’re talking serious money here. *As of Dec, 11 2022.
Mr. Buffett and Mr. Munger preach buying and holding the biggest and best U.S. companies and doing it for the long term. A number of years back, I believe around the year 2000, Warren Buffet and Ray Dalio, who ran one of the world’s largest hedge funds, made a $1 bet. The wager was to see what would perform better over the coming decade, Dalio’s hedge fund, which was highly active, vs. Buffet’s company which was highly passive. At the end of the decade, passive won and Dalio had to pay up. It was a fun exercise in investment philosophy, and buy and hold won. Now to be fair, I do believe there is a place for active management, particularly for an investor who is approaching retirement (3-5 years out) and needs to start planning for retirement income distribution. For the folks we work with who are pre-retirees, we often will use a portion of their overall portfolio and be a little more tactical to ensure they have ample liquidity and income as they transition from accumulation to distribution. The bulk of our equities for all of our clients, however, is invested in U.S. Large Cap Value dividend-paying stocks with a passive tilt.
Disclosure: One cannot invest directly in an index. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Investing involves risk and you may incur a profit or loss regardless of strategy selected, including diversification and asset allocation. Examples are for illustration purpose only and do not represent an actual investment. Dividends are not guaranteed and must be authorized by the company's board of directors. Investments mentioned may not be suitable for all investors. Prior to making any investment decision, you should consult with your financial advisor about your individual situation.