Compounding Wealth Production
Vegetable gardening fascinates me in both its simplicity and productivity. Mix dirt with nutrition, balance the PH, add sunshine and water, and you can grow anything! And as you encounter problems, there are only four conditions to investigate. Compounding the dividends of great businesses over time is one of the simplest, and historically one of the most effective ways to build wealth. Many of the greatest investors America ever produced would attest to this, and this strategy may be most responsible for the great Warren Buffet’s investing success. What makes the compounding of wealth a wonder, and why don’t more people do it? What are the critical dynamics of this investing strategy?
Albert Einstein declared compounding returns to be the 8’th wonder of the world, and he was smart enough that, when placing something on that scale, we should find out what it is. Reinvested dividends buy additional shares of a stock, which increases next quarter’s dividend, which will buy more shares over time, and so on. This process also compels dividends to buy fewer shares at higher prices, and more shares at lower prices, a key component of long-term returns. Apply this process to a business that increases its dividend annually, and dollar cost average into the position each month, and you have started the engine of a wealth production machine. Einstein discovered the chart on this process mirrors the bottom right quarter of a standard circle, consisting of three stages: 1) share accumulation with slow, methodical growth, 2) lift-off, as returns on investment escalate, and 3) parabolic growth of the value of the position with expanding returns.
The two likely reasons why investors don’t more often apply this incredible strategy, at least as part of their overall investment approach, are ignorance and impatience. Either they don’t know about it, and Wall Street has no vested interest in sharing it with them, or they are too impatient to consistently apply it over sufficient time to experience the wonder. Don’t let that be you! The three associative conditions to this investing strategy are as follows:
Invest only in businesses of such high quality that, short of a fundamental change in the company or industry, you’ll never sell. This means capital efficiency, industry domination, large and increasing free cash flow, a moat against competition, dividend payment, and ideally, annual dividend increases.
Exercise disciplined buying. Have strict parameters for when to buy with a lump sum. Never buy unless those parameters are met, but when they are met, always buy. Keep individual positions to 5% or less of the total account value.
Understand the time component. Your timeframe is your lifespan. Do not delay unnecessarily. Make sure dividends are reinvesting (without cost), and try to never stop dollar cost averaging into the position, either with dividends, or new dollars, or both, but remember the 5% rule mentioned above!
Three issues, that’s it! It’s even simpler than vegetable gardening, and far more productive, at least financially. May God bless the allocation of your hard-earned capital. Think about it, Shaun.
“If you aren’t willing to own a stock for 10 years, don’t even think about owning it for 10 minutes.” ~Warren Buffet
“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.” ~Warren Buffet
“You should have invested my money with the bankers, and at my coming I should have received what was my own with interest.” ~Matthew 25:27
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial.
All investing involves risk including the possible loss of principle. No strategy insures success or protects against loss. Dividend payments are not guaranteed and may be reduced or eliminated at any time by the company.
Dollar cost averaging involves continuous investment in securities regardless of fluctuation in price levels of such securities. Investors should consider their ability to continue purchasing through fluctuating price levels. Such a plan does not insure a profit and does not protect against loss in declining markets.
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