Global economic crisis notwithstanding, it’s a safe bet that many Australians will devote a sizeable part of the family budget to buying gifts for friends and family. Indeed, many economists are certainly hoping this will be the case as our economy is in dire need of some stimulation. But as any parent knows, there are few Christmas presents that retain their lustre for very long. Soon after the wrapping has been torn off, many toys will be gathering dust in the corner of the room and you will be left wondering whether all the effort and cost was really worth it.
I’m certainly not going to argue that you shouldn’t give the kids any presents; on the contrary I think you should give them the best present they will ever get. However, it will come with the clause “not to be opened until 2028”. Undoubtedly there will be few, if any, five year olds that will appreciate this, but you can be certain that they will change their tune down the track. Let me explain.
We all know that the share market can be a very scary place in the short term, in fact given the past 12 months we should now understand this very well indeed. But that doesn’t alter the fact that the market offers amazingly attractive returns over the long term. So as long as you can afford a longer time frame and ride out any short term volatility, your investment dollar is well placed.
With dividends reinvested, the average total investment return for the Australian market is 13.9%pa. That might not seem like much, but over time it can yield phenomenal results. This is due to the power of compounding, and although we usually associate this with savings accounts, it applies to any investment where your income returns are reinvested.
Chart 1 is the Long term performance of the Australian share market. Represented by the All Ordinaries Accumulation Index 1979 – 2008. Logarithmic Scale.
click to enlarge
To gauge just how powerful compounding is we can apply what is known as the “rule of 72”. This provides a reasonable estimate of how long it takes your investment to double given a certain rate of return; all you do is divide 72 by the annual investment return. So assuming that the long term rate of return on the market stays close to 13.9%, we can expect an investment in the market to double in just over 5 years (72/13.9 = 5.18). Of course in reality, it’s not likely that you will experience a nice even rate of return from one year to the next, but over the long term it provides us with a very reasonable estimate.
To put this into dollar terms, imagine you invest $2000 into a mix of quality blue chip shares when your child is born, and you reinvest all the dividends. By the time the child reaches 21, they will be sitting on a portfolio worth over $27,000. Still not impressed? Well, what if you decided to contribute an additional $1000 per annum (that’s less than $20 per week)? Again, based on the long term historical average return of the market, your child would receive for their 21st a portfolio worth over $105,000! Furthermore, the portfolio would be generating thousands of dollars in dividends each year (not to mention the tax benefits of franking credits). It really is the gift that keeps on giving.
Chart 2 illustrates $2000 invested in 2008, with dividends reinvested and $1000 added each year. Based on an average annual return of 13.9%
click to enlarge
So if you are struggling to think of presents for the children or grandchildren (or even yourself), why not consider putting some money into the market? The DividendKey program specifically focuses on building substantial wealth through conservative long term income investing, and is perfect for those wanting to generate these kinds of returns. (www.dividendkey.com)
Ask yourself what your child or grandchild would prefer for their 21st birthday - an engraved pewter, or a portfolio worth close to a hundred thousand dollars...?
Make the markets work for you