If you wanted to accumulate $1,000,000 worth of Johnson & Johnson stock over the past twenty-four years, there are two straightforward ways that you could have accomplished it: some variation of lump sum investing or dollar-cost averaging.
(1) If you wanted to make an investment in Johnson & Johnson stock on August 19th, 1989 that would be worth $1,000,000 today, you would have had to set aside $43,000 in 1989. That would be roughly the equivalent of coming up with almost $100,000 in terms of today’s purchasing power.
(2) You could have initiated a dollar-cost averaging program. To have $1,000,000 today, you would have had to put $432 into Johnson & Johnson stock every month since 1989. That would have been about $125,000 in nominal dollars, which would be time-consuming to adjust for inflation (setting aside $432 per month in 1989 was really the equivalent of setting aside $997 today, setting aside $432 per month in 2000 was really the equivalent of setting aside $678 per month today, and so on). To make it more accurately mimic real life, you’d probably want to simulate a realistic dollar amount that steadily increased over time.
The lesson isn’t to play a “what could have been” game with Johnson & Johnson stock. For the most part, we are all capable of finding stocks that will grow 8-12% over the long-term. Dollar cost averaging into Exxon, Coca-Cola, Procter & Gamble, Johnson & Johnson, and Colgate-Palmolive is not a maneuver limited to those with a nuclear physics degree from MIT.
Rather, it’s to point out how to measure your progress towards your goals: everything about investing comes down to your growth rate, the amount of money you have to allocate, and the amount of time you can set that money aside for. Those are the three variables that should be swimming through your head when you think about your long-term investing planning. Put me in a room with a case of Bud Light and a calculator, and I’ll be set for the night. It’s amazing to see how the numbers change if you bump your monthly contribution in Exxon stock from $100 to $200, or intend to let it compound for twenty-five years instead of fifteen.
If you give Chevron ten years to compound, you turn every dollar you set aside in 2003 into $4.57 today. If you give Chevron twenty years to compound, you turn every dollar you set aside in 1993 into $10.51 today.
That’s it. It can’t be broken down into the basics much more than that. We all know the companies that run the world and grow annually in that 8-12% sweet spot. We all know the compounding results with blue-chip stocks enter that Einstein “compounding is the 8th wonder of the world” territory once you leave the capital untouched for half your investing life. From there, it’s all about the savings rate. That’s the great conceit about personal finance writing—even though people like me spend most of our time writing about specific companies, the real secret to wealth-building is finding a way to set aside another $100 or $200 per month on a reliable basis. Setting aside $200 per month at 10% for twenty years will get you a little over $150,000. But if you can find a way to set aside $350 per month, you only need 5.5% annual returns to end up in the same place twenty years down the road.
Originally posted 2013-08-19 23:26:41.