If I offered you $10 million right now, or a penny that doubles in value every day for a month, which would you choose? In this episode, we explore this question and how it applies to your investment portfolio.
This is Greg Denewiler, and you are listening to another episode of the Dividend Mailbox, a podcast about dividend growth. Our goal is to stuff your mailbox full of dividend checks and make each year’s check larger than the last.
As promised in the last episode; here is the penny story. So, you may have heard in compounding it’s used as a great example for showing how strong and powerful compounding is. The question becomes: if you had a choice- I’ll give you one penny and it doubles every day for thirty days, or I will just give you ten million dollars right now. Which would you like? The ten million dollars or the one penny? Because you already kind of know just by the question, you probably want the penny. But here is how it works. So, on day one, one penny, at the end of the day is worth two cents. Day two, four cents, day three, eight cents. Well, you get the picture here. You get out to day ten, and it’s worth slightly more than ten dollars. One thing I want you to keep in mind is day ten, we’re going to call that the first decade. And then we go on out, day fifteen it’s up to $327. We get to day 20 and it’s a little over $10,000. Now let’s call that the second decade. So now we keep going, and as you can tell the numbers are growing rapidly. So, we get out to day 25, we’re at $335,000. Day 30, it’s $10,000,737. Clearly more than 10 million. Just think about this, if it happened to be a 31-day month, it’s now up to a little over 21 million. So that’s the penny story. The reason I bring that up is that I think there are several lessons built into it. One of them is it’s kind of interesting when you look at this, at least if you’re into trying to make money, the magic starts to happen in the second decade, or in this case day 10 because you go from one cent to ten dollars. That’s- you know that’s really not that big of a deal. You kind of look at that and you go “eh, so what”, that’s not much. But the second decade, the same numbers are at work, you go from 10 dollars to 10,000, now it is starting to get a little interesting. But when you get to day 30, there aren’t very many people that aren’t interested in what happened there. So, you’ve turned $10,000 into a little more than $10,000,000. That really is the power of interest accumulating and then earning interest on interest. Another big takeaway from this I think is also, the key is to have the mindset on day one. Because you have to put the process in place- get it going- because when you get out to day 20, you can’t wake up and double $10,000 in one day. If you don’t have a process in place, it’s just really hard to start it up. And then especially when you get out toward that third decade, you’ve got some really big numbers that are moving- that doesn’t happen overnight. So, it’s really all about mindset. It’s the old Chinese proverb: the journey starts on the first day, on the first step. Now, you’re probably thinking, well first of all, what does this have to do with me because I can’t double my money every day. And I really can’t double it every year. I mean that just- the risk you’d have to take to try and do that is just asking for major trouble and it’s really not realistic. So how does this apply to me? I’d like to go back to when I started in the business in 1979. And at that point, the S&P 500 was at 103 and the Dow was below 1000. And if I would have invested- which by the way, I really wish at that point I was aware of the dividend story- because in 1979, if I invested $10,000 into the market and held it for the entire period, that would have grown, just the price appreciation to $437,000. Now if you add in dividends, that number grows to a little over 1.3 million. Now one thing I want you to keep in mind- you know- that’s three times when you look at dividend reinvestment. But the return just goes from 9.3% to about 12.3%. So an extra 3% a year, or about a little more than 30% extra return, triples the amount of money you have at the end of the period. That’s a version of the penny story really playing out. Now, Charles Schwab says that the average age of a new investor is 35. Well, at 35 your average lifespan is around 85 so that means you have 50 years to invest. So let's go back and take the same $10,000 and look at September of 1971, and if you invest, that 10,000 would have grown to $449,000. Now, it’s kind of interesting that in our example earlier where we started in 1979, it was just slightly less than that number. That’s only $10,000 more, but you invested eight years earlier. So, over the next eight years, you really didn’t gain anything price-wise. For those looking back at market history, you know that the 1970s was basically considered a dead decade as far as returns- they didn’t go anywhere. Here’s part of the point of this whole dividend story. If you throw the dividend reinvestment in there, that $448,000 grows to a little more than 1.8 million- so you picked up an extra half a million dollars. No price appreciation, but dividend reinvesting really turned it into a decent return on your money. So now, I want you to think about this. Going back to 1979, if you knew in advance that in 1987 we were going to have a one-day crash of 20% in October, or in 1990 we were going to hit a recession. 1997- we were going to hit the Asian debt crisis, which basically emerging market country’s debt sort of imploded. Then in 19- I believe it was 1998, you had a long-term capital management collapse. Which, by the way, had a couple of Nobel economics prize winners in it that were supposed to have known everything. And guess what? They got bailed out, and it was really one of the first fed bailouts so, being smart doesn’t necessarily mean successful. Well, anyway, moving on. Then we hit the 2000 Dot-com collapse where the NASDAQ went down by about 80%. Then you have 2008 where, you know, we all know it was- it got pretty ugly. Just kind of a little- I guess a little market history- actually the market decline in 2000-2002 was almost as bad as 2008. The difference was, in 2008 everything went down, there really was no place to hide. Then you get to 2020, and in March, probably don’t have to tell you what happened then- the market is down 35% in three weeks. Knowing all that, would you still have invested? Well, the key is, there’s always a lot of reasons why you don’t want to invest or why you might want to wait. However, when you go from just price appreciation of 437,000 to 1.3 million, dividends are going to help get you through this no matter what happens. You know, have dividends always been an important factor of the market? Going back to 1980, you look at the S&P 500- well first of all, right now, there are 385 companies of the S&P 500 that pay a dividend. Going back to 1980, the lowest number was 351 and the highest number that paid dividends was 469. So its really been fairly consistent, and if you go back in history, back before that, dividends have always been significant. You know one thing that does happen, the market evolves. So you look at the S&P 500 payout right now, 30 years ago information technology was basically, you know with the exception of an IBM or something, it was really- I’m not going to say meaningless but it was very low. Some of the high growth ones, especially going back to 2000 when we got into the big market decline, most of them didn’t pay a dividend. Microsoft didn’t. Apple didn’t. You know Facebook didn’t even exist. Well now, information technology is the largest component of the dividend payout of the S&P 500, it’s 17%. So, it’s not whether it works or doesn’t work. Things just evolve over time. As far as the dividends right now on the S&P, it’s not quite $60. But Bloomberg expects by the end of this year it will be $61. 2022 it will be up a little over $65, 2023 it’ll be up to $69. Of course, those are estimates, but that’s what they are expecting. So now, you might be thinking- well ok, with all the debt we’ve been put on, all the fed intervention in the market, interest rates at zero, you know, can this work for the next decade? I mean are we- can we really expect to continue to get 6% dividend growth?” Well, next episode, you will find out.
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