Everyone knows the earlier you invest, the more you save. But there’s so much more to it. I’ll also let you in on a little secret about quality companies. Of course, it’s not a complete discussion about investing early if I don’t illustrate the essential concept of compounding…
The earlier you invest, the more you save
You may think that it is a no brainer that the earlier you invest, the more you save. But actually, there are two aspects to it.
All of you already know that if you start saving $1,000 every year, that in 10 years, you’ll have saved $10,000. If you start saving five years later, in 10 years, you’ll only have $5,000.
The second aspect is that, the earlier you invest those amounts, the sooner your money starts to work for you. And that’s where compounding comes in. I’ll talk more about compounding in the last point.
In essence, if your end goal is to accumulate $5,000,000 of assets, the earlier you start investing, the less money you need to draw out from your own pocket.
However, the bottom line is that you never lose money, which is one of the 5 Important Investing Concepts.
To reduce the chance of losing money, buy quality, stable companies at reasonable valuations. What’s value? Ben Reynolds wrote a great article about Value + Growth + Dividends = Dividend Growth Investing that explains about value and other goodies.
Quality companies become more valuable over time
Quality, stable companies become more profitable and valuable over time. Given the time-value of money, the earlier you invest in a great company, the cheaper it is.
In the 10-year period of August 31 2006 to 2016 Stella-Jones Inc.’s (TSX:SJ) total returns were 814% or an annualized rate of return of 24.8%. $10,000 invested on August 31, 2006 would have grown to $91,407.
Of course, the hard part is identifying great companies early. Stella-Jones have only paid a growing dividend for 11 years. Given that some dividend-growth investors don’t invest in a dividend-growth stock until it has at least a five-year dividend-growth streak, an investor might have bought Stella-Jones six years ago.
Even so, from August 31, 2010 to 2016, a $10,000 investment in Stella-Jones would have grown to $83,933 for a total return of 539% or an annualized rate of return of 36.2%.
So, don’t shrug off a great company just because you missed the first parts of its growth. If it’s really the quality company that it is, it should continue to deliver.
Identifying the right companies for your portfolio is an essential step but don’t forget to check their valuations to ensure they’re not too expensive. If you overpay for even the greatest company, your returns will suffer.
Is Stella-Jones a good investment today? Check out my recent growth stock analysis on Stella-Jones to find out.
The earlier you invest, the less risky your investments can be
Let’s say you invested $1,000 per year for your child since they were born at a rate of return of 5% per year. By the time they start college or university, 19 years later, the initial $19,000 investment would have grown to $32,065.
If your child takes on a part-time job and manages to pay their tuition fees, then the money can continue growing. You decide to continue contributing $1,000 a year until your child was 25 years old. The original $25,000 investment would double to $50,113 in year 25.
The following factors can boost your end result:
- Contributing more than $1,000 a year (perhaps $2,000 a year?)
- Achieving a rate of return higher than 5% (perhaps aim for the average market returns of 7-10%?)
- Your contribution years increase (perhaps you decide to contribute 30 years instead of 19 or 25?)
Typically, the higher return an investment is expected to deliver, the higher risk it may be. Last month I discussed if high yield means high risk. The main concepts discussed there can be applied to stocks in general as well.
That’s why if someone starts to save and invest close to retirement (say, five years before retirement), they’ll be forced to take on more risk by investing in investments with high yields or expected returns.
So, the earlier you invest, the less risk you can choose to take on and still achieve your financial goals. And your chance of losing money will be lower.
In general, buying mature companies which pay decent, growing dividends can still generate a good return for you.
Mature dividend growth companies with ~4% yields
- Telus Corporation (TSX:T)(NYSE:TU) which yields 4.4% and is expected to grow its dividend per share by about 7% per year
- Fortis Inc (TSX:FTS) which yields 3.7% and is expected to grow its dividend by 6% through 2020
- Toronto-Dominion Bank (TSX:TD)(NYSE:TD) which yields 3.8% and is expected to grow its dividend by about 5-7%
- The Coca-Cola Co (NYSE:KO) which yields 3.3% and is expected to grow its dividend by 5-6%
The dividends of these companies already account for about half of the returns if you’re aiming for a 7% rate of return.
Compounding returns: Get your money to work for you
Compounding returns (from interests, dividends, or growth) works in your favour the longer you have your money invested given the investment continues to grow (i.e. your rate of return).
Let’s take a look at the returns of Stella-Jones Inc in the last 15-, 10-, and five-year periods.
From August 31, 2001 to 2016, over a 15-year period, a $10,000 investment would have grown to $826,140! Price appreciation accounted for 7839% of the returns as $793,928 of the returns were from price appreciation (96% of total returns) and $32,211 of the returns were from dividends (4% of total returns). The total returns were 8,161% or an annualized rate of return of 34.2%.
From August 31, 2006 to 2016, over a 10-year period, a $10,000 investment would have grown to $91,407. Price appreciation accounted for 780% of the returns as $88,039 of the returns were from price appreciation (about 96% of total returns) and $3,367 of the returns were from dividends (nearly 4% of total returns). The total returns were 814% or an annualized rate of return of 24.8%.
From August 31, 2011 to 2016, over a 5-year period, a $10,000 investment would have grown to $48,184. Price appreciation accounted for 368% of the returns as $46,849 of the returns were from price appreciation (about 97% of total returns) and $1,335 of the returns were from dividends (almost 3% of total returns). The total returns were 381% or an annualized rate of return of 36.9%.
5 years can make a big difference
Notice that by investing in Stella-Jones in 2006, merely five years late, a $10,000 investment delivered $734,733 fewer returns! The huge difference was largely due to Stella-Jones’s monstrous compounding growth rate of north of 30% in the first five years. (That’s abnormally high and at least three times more growth than the average market returns of 7-10% a year.)
The same concept can be applied to other investments — the higher the rate of return, the faster the compounding; the earlier your investment, the sooner your money starts compounding.
The earlier you invest, the sooner you learn the ropes
Some people think investing is too hard, too easy, or too random. Some people don’t know where to start. A good way to start is by learning from others. If you can learn from an experienced mentor, that’s great. If not, here are some of my favorite books on dividend investing that are easy to read:
Investing is not as easy as just identifying the top companies from each industry and then buying and holding them. Fundamental and technical analysis can come into play. (Though I’d argue, fundamental analysis comes first.)
Investors should also know their financial goals, whether it’d be accumulating a final sum of assets in year 30 or 50 or earning $3,000 or $10,000 of passive income per month. Only when you have the end in mind can you work your way back to decide the steps and mini-goals to get you there.
The earlier you invest, the sooner you learn the ropes about investing, and the less likely you’re going to make a big mistake later on. It’s better to find out your investment style, risk tolerance, and temperament early on. It’d be better to make mistakes early on (instead of later on) as it’d be less damaging when you start with a small sum of money.
The sooner you save and earn from investing, the less risk you can take and the faster you’ll achieve your financial goals. Don’t hesitate to learn from others and ask questions.
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: At the time of writing, I am long TSX:SJ, TSX:T, TSX:TD, and TSX:FTS.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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