An Important Lesson on Investing, Courtesy of Millennials
One of the most popular trends in finance right now is “robo-advisors.”
These automated portfolio managers are currently handling more than $20 billion. And they’re expected to control $255 billion by 2020.
As an investor, all you need to do to use this technology is answer a couple of questions online. Then, faster than you can say “bleep bloop,” you’ll be given a customized list of ETFs to invest in.
The target audience here is tech-savvy Millennials. It’s a little extreme, but I do appreciate the push to get younger people investing.
I’ve long stated that the way portfolios are structured - and marketed - to Generation Y is wrong. The idea is that the younger you are, the higher your risk tolerance should be. (After all, younger people have more time to recover from losses, right?)
It should be the opposite. Millennials shouldn’t be trading small cap tech stocks or biotechs. They should be pouring into boring (but reliable) dividend stocks...
For example, they should invest in toilet paper.
Kimberly-Clark (NYSE: KMB) - which owns several bathroom tissue brands, including Scott and Cottonelle - pays a decent dividend, currently $3.68 annually for a yield of 2.76%.
The other thing to like about this investment? Toilet paper is a consumer staple. It has been for more than 100 years. And it’s unlikely someone’s going to come along and disrupt this market anytime soon.
That fact has kept - and will keep - Kimberly-Clark shareholders profiting. In fact...
If you had invested $5,000 in Kimberly-Clark at the end of March 2011, your investment would currently be worth more than $12,311. And if you had reinvested the dividend, your total number of shares would have increased from 77 in 2011 to 91.3 today.
In just five years!
The power of dividend-paying stocks is time. The longer you allow a dividend reinvestment program (popularly known as a DRIP) to work, the greater the impact compounding has on a portfolio.
We can see this at work in J.P. Morgan Asset Management’s 2016 “Guide to Retirement.” One of the items highlighted in this report is the importance of investing as early as possible.
They present a hypothetical situation where four young investors - Chloe, Quincy, Lyla and Noah - are each able to invest or save $10,000 annually.
(Remember, this is a hypothetical. So don’t think too hard about how an average 25-year-old would ever be able to set aside an extra $10,000 a year.)
- From age 25 to 65, Chloe invests in stocks, earning a 6.5% return
- Quincy invests in stocks from age 25 to 35, also earning 6.5%
- Lyla gets a late start, investing from age 35 to 65, but still earning 6.5%
- Noah stays in cash from 25 to 65, earning 2.25%
Here’s how that looks over time...
Chloe, after investing $10,000 per year from age 25 to 65, is the clear winner. She ends up with nearly $1.9 million in the end.
That’s almost three times what Noah ended up with after keeping his money in cash. (He obviously didn’t read my column from last week.)
But the real power of compounding is on display in the lines for Quincy and Lyla.
Quincy sets aside only $10,000 annually from 25 to 35 - just $100,000 total.
And Lyla - starting later in life - invests $10,000 every year from 35 to 65. Yet despite putting more money aside than Quincy - $300,000 total - she ends up with less.
It really illustrates just how important compounding and time are to your investment success.
Over the years, I’ve hammered my friends and family with pieces of data like this - especially those who have young children. Setting up a dividend-paying stock portfolio for your kid is one of the greatest gifts you can give them.
One of my friends did this for his son when he was 4 years old. By the time he’s 25, he should be sitting on a nice chunk of change. (I’ll be interested to see if that money gets to keep on running or if he cashes out to buy a home.)
But as for you...
Whether you’re a Millennial or a retiree, I can tell you this: No one needs a robot managing their long-term investments.
You can do it yourself. Simply. Just build a portfolio with dividend-payers from a diverse group of sectors. Then let time and compounding do their work.
A good DRIP is the only automated investment program you’ll ever need.
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