Dear Mr. Berko: Could you please explain how the rule of 72 works for growing the principal and income value in a stock portfolio? I've been out of college for nine years. I am 30 years old and have two children. My spouse and I have paid off all our debts (except for our house and car), and we're ready to invest. We don't want to be aggressive, and we've heard the rule of 72 makes sense for the long term. We'd appreciate your explaining how this works.
— NB, Weatherford, Okla.
Dear NB: The rule of 72 is a 20-to-30-year strategy and assumes that you'd rather earn a slow $20 than make a fast $10.
The rule of 72 could make your life uncomplicated and comfortable. R/72 magically tells you the number of years it takes for money to double when compounded at a fixed rate. In this example, consider a $10,000 certificate of deposit paying 4 percent. Because 72 is our magic number, we divide it by 4 (the fixed interest rate), giving us 18. This tells us that $10,000 at 4 percent, compounded once a year, will grow to $20,000 in 18 years, when you'll be 48. So after 18 years, you'd earn $800 in annual interest (4 percent on $20,000) from a $10,000 investment made when you were 30. That's 8 percent. If the CD compounded at 4 percent for 18 more years, it'd grow to $40,000 by the time you're 66. You'd be earning $1,600 in interest (4 percent on $40,000) from your original $10,000 investment made 36 years previously. That's 16 percent.
Assume you have a $10,000 CD paying 6 percent. According to R/72, if the CD were compounded once a year, it would double in 12 years, to $20,000. You'd be 42 and earning $1,200 in interest on a $10,000 investment made when you were 30. That's 12 percent. If you allowed the CD to compound for 12 more years, it would double again, to $40,000. You'd be 54 and earning $2,400 in interest on a $10,000 investment made when you were 30. That's 24 percent. And if you allowed that 6 percent CD to compound for 12 more years, it would grow to $80,000. You'd be 66 and earning $4,800 on a $10,000 investment made 36 years previously. And if you let it compound for another 12 years, at 78, you would have a $160,000 CD, and you'd be earning $9,600 a year in interest. That's 96 percent, with little risk, fuss or bother.
If you compounded this $10,000 6 percent CD quarterly like a stock dividend -- that's four times a year -- it would grow more quickly and be worth $160,000 when you're 74 years and 6 months old. You'd be earning $9,600 in interest three years and six months sooner. Let's raise the interest rate to 8 percent. Compounding $10,000 at 8 percent annually would double it every nine years, and it would grow to $160,000 in 35 years. But compounding $10,000 quarterly, it would grow to $160,000 in 32 years and eight months, and your income would grow to (8 percent of $160,000) $12,800.
So, select a portfolio of dividend growth stocks, such as AT&T, Altria, Iron Mountain, Omega Healthcare, Southern, AmeriGas Partners, Dominion Energy, W.P. Carey, Exxon Mobil, Owens & Minor, and Uniti Group, which yield 4 to 8 percent and grow their dividends yearly. Reinvest your increasing dividends quarterly and allow the magic power of compounding interest to grow your retirement income more quickly. A $10,000 investment in most of the above issues, with growing dividends reinvested quarterly, could double in 10 years, quintuple in 20 years and be 16 times higher in 30 years. Those are commanding returns. However, many are terribly boring and unexciting.
There are many good business development companies yielding 8 to 10 percent and some well-managed mortgage real estate investment trusts and master limited partnerships with attractive 7 to 9 percent yields. And there are many investment services that research and recommend higher-yielding common stocks and even high-yield preferred issues, which might be just ducky as long-term investments if the dividends were reinvested.
Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775, or email him at email@example.com.