The Frugal Farm Living life deliberately

That is the answer. Excluding splits, which are rare and unpredictable, reinvesting dividends from dividend paying stocks is the only way to get 'compound interest' type growth in the stock market. As I'm sure you were once aware (in that econ 110 class long ago), FV=PV*e^rt. r is the rate. t is time, PV is present value and FV is future value.

Right now is an interesting time in the market. The S&P 500 is down ca. 5% year-to-date. Gold is up 7% in the same time period. Silver even more. (Which really only means that the dollar is worth less - if you don't like gold, you can see it in oil. or milk. or ... but I digress). The one upside in the drop in the s&p is that yields of some stalwart blue-chips are up. While t-bills are yielding a pitiful percent and a half (1.45%), and your savings acount is likely worse. or not much better. There are a number of extremely well known stocks that are paying, 4%, 5%, and even 6% and up in dividends. Now, before scoffing at that yield, many of these same stocks are the members of the s&p 500 that have been pulling the average return of the s&p up for years. Take Pfizer for example. Big company. Rakes in billions (with a B) in revenue. And is currently paying out a 6% dividend! And if you think buying PFE for 6% is dumb, look at the track record of capital gains as well.

And here is the clincher. Pfizer has increased their dividend annually for the last 30+ years.
If you remember your math, you know the formula above is exponential and (eventually) gives the 'hockey stick' graph. Well, what happens when 'r' is growing in the equation above, according roughly to the equation above?

(too deep? too obvious? what do you think? -- oh, and if you learned all this before in school, please tell me how I *should* have payed attention)

Ok, everything I've posted so far is pretty self-explanatory (and after all, no one ever said finance is rocket science). But here's the thing. For the first 10 years after college I invested almost exclusively in growth stocks. But do you ever really get compound growth in growth stocks? (And there is one way you do, but tends to be rare and unpredictable).

Here in Idaho JR Simplot is a pretty famous guy. Simplot is the man who modernized potato processing. A Billionaire, and was the primary funder and major shareholder of Micron. At any rate, how he got his start is somewhere between reality, myth, and legend, but the story that gets repeated is loosely along the following lines : JR as a teenager ended up with a couple head of cattle. (2 cows for the laypeople among us). He had these cows bred and they produced young. Now rather than selling out and taking his profits, he realized with exponential, compounding growth (every cow produces 1-2 young a year and those are ready to produce 1-2 young in 1-2 years after that), he could build an enormous herd worth a vast fortune and live off a portion of the proceeds of the heards annual growth.

It is compound interest at its finest. And a teenage farmboy from idaho got it. Of course, 100% return is pretty rare in the world of dollars, and the cattle market can be volatile, but in terms of cattle, you can really get 100% annual returns compounding. And interest is most accurately measured in the units it is paid in - dollars on dollars in the bank. Calfs in Cattle in the field. And Shares when dealing with stocks.

Back to stocks: - so, in the strict sense of compound interest, do growth stocks compound? No. And although every financial planner will tell you about compound interest as the key. And most will proceed to push one toward growth stocks. You just 'can't get there from here'. You don't get compound growth from growth stocks expect in stock splits. You see, when you buy a great growth stock, and 10x your investment, and it falls, you still have the same number of shares. No growth. No sold at the right time, they could be converted to money, and one can calculate a return - but it isn't a compounding.

So, everyone agrees (most everyone anyway) agrees stocks are a good place for money, but everyone also knows you need compounded returns - simple returns don't get you there, so where to go? (another blog entry to come -- but any thoughts? too deep? too obvious? )

As I glanced at the site today, I realized that it may appear that Frugalmom and I have delegated the financial responsibilty to me. But that really isn't the case. In fact, for most our years together, we've actually shared the responsibility. Frugalmom tends to take care of the bill paying, and credit card and bank accounts, and I tend toward the investing accounts. But I'm really lucky, Frugalmom is indeed quite frugal. She doesn't ever spend for spending's sake. She loves a deal, but doesn't buy what she doesn't need.

I was talking to a friend who's wife is, as he described her, a spendthrift. I have a hard time imaging the extent to which fundamentally different money management philosophies might strain a marriage. Frugalmom and I tend to naturally align on long term goals, and while we haven't always been perfect, we've been pretty good. I'm really grateful that she is such a good money manager (she used to say she majored in business 'cause she likes to be the boss :-)). It is fun to have and reach shared goals.

Once you are saving money, you have to get a return. Even in Matthew 25 we see that a return is important. (And yes, those talents are a monetary unit - see Exodus 38:24 and for a more thorough explanation, but I digress). Anyway, how long will it take your money to double?

Enter the "Rule of 72". My dad (THANKS DAD!!!) started teaching me about compound interest when I was about 10. And the easiest rule of thumb to figure out compound interest is to divide 72 by the rate (e.g. 10%apr), and that is how many years it will take your money to double (7.2 years in this case). Pretty handy huh?

So at 5%

72/5=14.x (since it is just an estimating technique, I won't bother with the decimal.)

It takes 14+ years to double what you have invested.

Caveats: - works for compound interest only (simple interest would be 100/rate). And it isn't perfect, but it provides a quick easy way to see what compound interest does.

cool huh? I've enoyed it since I was 10.

Sounds obvious doesn't it? But until you start spending less than you make, you will never be free of financial worry. Spending less than you make doesn't make you immediately free of financial worry, but it will help.

Most people find they can take 10% out of each check (preferably automatically before you ever see it) and not miss it. By putting this away for a rainy day, you will soon have an emergency fund. There is a lot of peace in having 3-6-?? months worth of living expenses securely tucked away, hopefully earning a decent return. Takes a lot of the stress of 'involuntary job changes' away.