Dividends and How compounding works

The second most important rule in investing is to understand how compound interest works. The first rule is put your money in investments that help you compound interest.

Compound interest is the 8th wonder of the world. Albert Einstein said He who understands it, earns it: he who doesn’t, pays it.”

Your success an an investor is a function of 2 things:

Your net investment return over time; The length of time you remain invested.

In an article by R.B. Matthew and Doug McCutcheon of Longview Assest Management noted What determines your long term rate of return? Studies have shown that by far the most important factor is the asset class you invest in.

Investing in a portfolio of growing businesses, through ownership of publicly traded or private companies, will produce the highest unleveraged return.

The long return that matters is your long-term return, and for most asset classes, your long-term investment return is reasonably predictable. History teaches that over 20 or more years, your average return from investing in a portfolio of listed companies (stocks) is likely to be 7 to 10% before taxes.

Compound interest works: example $100,000 compounded at 10% per year.

Year 0 100,000

Year 5 161,000

Year 50 11.7 million

Year 60 30.4 million

Linking to dividend paying stocks, the key is to buy companies that are in a growing business over many decades, thereby allowing their value to compound over time on a before tax basis. (note there are many strategies to reduce taxes, but first earn it). A growing company earns a profit and if they consistently grow the dividend, it is very easy to hold for a long period of time.

There are more questions than answers, till the next time – to raising questions.

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