The Real Thing

There is only one path to wealth that is predictable and reliable.  Spend less than you earn.  Save and invest that money.  Let the money compound.  Do what you can to minimize taxes. Try not to do anything stupid with your gains.

This formula works but few follow it.  Based on my experience, most Americans don't get past the first step.  They are spending everything (and more) that they earn.  Those that get past that stage still have a hard time keeping their hands off the income the investment starts to produce.  Compounding only works if you are willing to reinvest and let your gains grow.

I am always interested in stories that demonstrate the immense power of compounding.  I saw one the other day in an investment newsletter, High Yield Investing, that is worth sharing.  These always help me from falling in the trap of putting my grubby hands on any gains I am lucky to obtain.

Coca-Cola went public in 1919 at $40 a share.  Today, each of those single $40 shares is worth $250,000.  But with its growing dividends reinvested it is worth a stunning $8.1 million. (By the way, that original $40 share is now throwing off $226,569 in dividends a year!)

A good lesson that there is nothing better in investing than finding a company that is growing its revenues, its income, its cash and its dividend.  Good dividend paying companies fell out of favor with the emergence of the tech revolution.  The lessons of the last few years seems to have brought dividends back in vogue. 

Over the years, dividends have actually accounted for about 40% of the total return of the S&P 500.  Taking dividends out of the calculation of total stock market returns over time makes a huge difference.  In fact, $1,000 invested in the S&P 500 at the start of 1936 with all dividends invested would be worth almost $1.5 million today.  You would have only $90,745 without the dividends according to High Yield Investing.

My favorite compound interest story still involves what has been characterized as one of the greatest steals of all time when the Dutch reportedly purchased Manhattan Island from the Indians in 1626 for the grand sum of $24 in blankets and beads.

However, if the Indians had taken the $24 and invested that sum at a 7.2% return and let it compound it is the Indians that would have gotten the last laugh.  Why?  $24 compounded at that rate for the last 385 years would now be worth almost $10 trillion.  That is $10,000,000,000,000! 

In the year 2000 I was curious as to what all of the real estate on Manhattan was worth in comparison so I called the New York City Assessor's Office.  At that time all of the real estate (including all of the buildings built on Manhattan Island) was only appraised at $125 billion!  Just think about it.  You take all of the investment in steel, concrete, infrastructure and the blood, sweat and tears of all that labor over all those years and it pales in comparison to the compound return on a mere $24.

Compound returns are the real thing.  That is why you need to make sure you have it working for you if you expect to accumulate wealth.  Knowing the power of these returns is also why I am so concerned about our country's fiscal position.  Time is not on your side when you are the borrower rather than the saver.   The numbers tell the story.