Compounding and planning — Part two

Shrewd investors use compounding to make sure all their money works for them. Combine that with a sound plan, and you’re well on the way to success. This is the second part of our article of June 3, 2022.


A sound plan for a steady return

As we said in our June 3 article, we feel you can do better in the long run if you set your sights lower and aim for a steady rate of return when planning your compounding strategies. In fact, a nine-per-cent increase each year compounded for five years will do better for your peace of mind than, say, annual returns of 10 per cent, minus 12 per cent, 20 per cent, 30 per cent and two per cent over the same time period — even though the increases average out to nine-per-cent a year in the latter case.

Of course, even if the return on your investments is more or less steady, you can still expect an occasional loss from time to time. You can compensate for this by setting your overall goals slightly higher. Aim for 10 per cent, when it’s a nine-per-cent yearly increase you’re after, for instance.

There are ways to improve the return on your investment without exposing your portfolio to greater risks. For example, when you contribute to an RRSP (Registered Retirement Savings Plan), don’t wait until the end of the year. Contribute as funds become available throughout the year. That way compounding works for you sooner.

Your best prospects for growth

Common stocks, of course, offer the best prospects for growth. Dividend-paying Canadian stocks in particular are a wise choice for most portfolios: They come with the dividend tax credit, after all.

Picking stocks with dividend re-investment programs is another good way to accelerate the compounding process. Generally, companies that offer such plans will re-invest your dividends while charging no commissions. That’s because no broker is needed to carry out the sale. What’s more, the company may give you a discount from the market price when they re-invest your dividends. Some will even let you add cash to the dividends they re-invest for you.

All of this makes for small gains in the near term. But over time — and with the magic of compounding — the little bit you save now through dividend re-investment can grow into much more.

Compounding encourages the notion of investments as a lifetime endeavour — an important idea to foster if you hope to achieve long-term investment success.

Investors normally think of compounding as getting interest on the interest on their interest, or dividends on their dividends on dividends. However, you can also think of it as building assets on assets.

That’s what a company does when it uses it retained earnings to expand its assets and operations. This is essentially what a so-called ‘growth stock’ does year after year.

Compound with growth stocks

Buying high yields stocks is not the only way, then, to take advantage of compounding. Fairly aggressive investors might also consider a portfolio of solid growth stocks and achieve the same or better results in the end (though they run the risk of irregular year-to-year results).

Here is a modest — and sound, we feel — growth portfolio that might help a balanced investor make use of the magic of compounding (provided they reinvest their dividends): Bank of Montreal (TSX—BMO; NYSE—BMO), Telus Corp. (TSX—T; NYSE—TU), Apple Inc. (NASDAQ—AAPL), Canadian Tire Corp. (TSX—CTC.B) and Agnico-Eagle Mines Ltd. (TSX—AEM; NYSE—AEM).

The overall yield of this portfolio is pretty good (3.4 per cent). Plus, we feel the dividends of these five companies are stable and should rise over the years. And your real gains in compounding with this portfolio could come through capital appreciation. All five stocks have good long-term growth prospects.

All in all, we think it’s the kind of portfolio that should help you avoid losses and make the magic of compounding work for you over the years.

This is an edited version of an article that was originally published for subscribers in the July 1, 2022 issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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