POWER OF COMPOUNDING (POC)

Dividend reinvestment plan (DRIP or DRP)

POWER OF COMPOUNDING (POC)
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POWER OF COMPOUNDING (POC)
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DIVIDEND REINVESTMENT PLAN (DRIP or DRP)

UNDERSTANDING "POWER OF COMPOUNDING" & "DIVIDENDE REINVESTMENT" ARE THE FOUNDATION OF INVESTMENT.

The example below says it all.

"........Look at the history of Coca-Cola. It went public on 1919 at $40 a share. Today, one of those single shares is worth $248,000. But with its growing dividends reinvested it is worth a stunning $6.7 million. ( By the way, that original $40 share is now throwing off $221,163 in dividends a year!)"

EFFECT OF DIVIDENDS ON GROWTH OF INVESTMENT
Usually stock returns are derived from future stock price appreciation and dividends paid for each share by the company. Dividend is a stockholder’s share of profit of the company’s profits paid to stockholders, usually in cash, rarely in more stocks (shares). Stock and share are the same and either may be used for the same purpose. The main idea behind paying stocks as dividend by the company is to preserve cash for the company's future needs. Not all companies pay dividends to their shareholders. Companies may reduce or stop paying dividends if a company’s earning falls. Many companies not only consistently pay dividends, but also increase dividends year after year.
Why full dividend reinvestment is a must to accumulate great sum of wealth is discussed below. Dividends that are are fully reinvested by buying more of company’s stocks creates a compounded growth rate of return, resulting in a huge sum over a long period. This is due to the power of compounding,as discussed in the previous chapters of this book.
The Dow Jones, S&P 500, NASDAQ, Wilshire 5000 Indices do not include dividends paid yearly in the rate of return. This is a very important factor that investors should be aware of. The real return of Dow including reinvested dividends would make the value of the "index to be over 250,000 points today" (1). This is compared to Dow values since inception in 1896 of less than 100 to maximum of about 14,000+ in 2007). "It is commonly known that it took the market 25 years to recover from its 1929 peak and the Great Depression. However, the inclusion of dividends in the index mitigates the effects of the Great Depression. A new all-time high is reached in January 1945 instead of November 1954 if dividends are included" (2).
If $107.23 was invested on 12/31/1919 into a Dow Jones index fund and all dividends were reinvested for more fund shares, the dividend income would have grown from $5.80 in 1920 to $8,715.12 by 2005 and the total investment (appreciation + dividends) would have grown from $107.53 to a $371,028.01 (3).

"Why dollar-cost average into these stocks now? Because the data from those really, really monstrous bear markets, the ones that accompanied the Great Depression, show that investors who bought dividend-paying blue chips and reinvested the dividend did just fine in the bear markets that lasted from 1929 through 1942." (4)
The Dow Jones Industrials dropped 87% from August, 1929 through June 1932. Even in April of 1942, the Dow stayed down to 74% from August, 1929 level. The Dow did not recover to 1929 price level until 1954. So an investor had to wait to break even from 1929 until 1954 if only the stocks prices were considered (4).
"But an investor who had collected dividends and reinvested them would have seen a 340% total return by 1954, according to the Wharton School's Jeremy Siegel, the author of "Stocks for the Long Run."" (4).
In a bear market as the stocks prices go down, dividend yields go up. The investor will get more dividend for each new and old invested dollar. An example of this is: Intel stock paid 1.95% dividend on Nov., 3, 2006. The yield became 4.64% on Feb., 24, 2009 as the price of Intel stock fell (from $20.51 to $12.57) plus increases in Intel's annual dividend from 40 cents a share in 2006 to 56 cents a share in 2009, a 40% increase. The bulk of the yield was a result of the drop in the stock's price (4).
The a
bove example indicates why even in a bear market one should keep investing to get the full benefits of dividend paying stocks.

The Table 66 is based on the interview of Sir John Templeton by Luke Rukeyser in his MPT ( Maryland Public Televesion) Television show " The Wall Street Week" in 10 January1997, Program # 2628- page13.

"RUKEYSER: You've noted that the Dow Jones Indusatrial Average has risen eight times since you were on the program in 1982. What are the chances it will rise another eight times in the next 15 years?

TEMPLETON: Very, very slim. But let's look at this way. Suppose I had been on your program at the very top day in 1929. The Dow Jones at that time reached 381. If you had put a million dollars into the market then, today you would have $17 million, or if you had reinvested your dividends you'd have $250 million today.

RUKEYSER: John Templeton, Thanks very much. I wish I had a million then."

( "The Dow Jones topped out at 386 in Sep 1929,..."

Reference:Saturday, March 22, 2008. Dow Jones Industrials 1929 Pattern. http://niftywhatcanhappen.blogspot.com/2008/03/dow-jones-industrials-1929-pattern.html )

The morale of the above fact that it is not the amount money one has initially invested,

(a) it is the time one gives to "Power of Compounding" to work on the investment. In this case approximately 67 years (1927 to end of 1996),

(b) one need to invest new money on the Dow Jones as frequently as she/he could, beside reinvestment of all dividends. In this case yearly average dividends during this period was less than ? 3%.

Table 55 shows the end value of a one million dollar investment in Dow Jones stocks from 1929 to end of 1996 (approximately 67 years), with and without dividend reinvestment.

Table 55

Amount of Dow Jones Stocks Purchased

in

Millions of $

Year

Investment Started

Dividends Earned

Year Investment Ended

End Value of Investment in Millions of $

1

1929

Not Reinvested

1996

17

1

1929

Reinvested

1996

250

The incredible end values in Table 66 above illustrate the benefit of fully reinvesting all dividends, consistently, year after year, over a long period of time. Further, the value of the investment will grow even more rapidly if the company raises its dividends every year. Even more so if small amount of principal is added frequently. Full Dividend Reinvestment year after year for a long period is the backbone of the
investment and is one of the best ways to accumulate a great deal of wealth. 70 percent of the total returns for some investment growth comes from dividend reinvestment (5).
"First the dividend yield, an important part of long-term stock market returns. In fact, in the long-term the stock market return of 9.5 percent is a 4.5 percent dividend yield and 5 percent earnings growth" (6). This dividend yield was either referred to S&P 500 index fund or Dow Jones index. "In his book, Stocks for the Long Run, Wharton Professor Jeremy Siegel proves that stocks have been the best performing investing for the past 200 years in the US. Equities outperformed other assets classes such as gold and fixed income..... Dividend payments have historically accounted for 40% of the average annual stock market return. A lesser
known fact is that reinvested dividends have provided for 97% of historical stock market returns" (7).

Lipper Analytical Services , Inc reported that between 1975 to 1990, the Dow Jones Industrial Average totally gained 831%, of which 485% (58%) was due to dividend reinvestment (8) .


Readers should note the ranges (40 to 97%) mentioned as regard rate of return of the dividend quoted by various authors. This differences could be due to many factors, most likely mainly due to stock selection in the portfolio and market conditions - bear or bull market.


The f
ollowing section shows the difference between investing in the present format of social security fund investment Vs. S & P 500 index investment with effect of reinvestment of dividends and inflation.
The table 67 shows the average annual special-issue interest rates and effective annual interest rates (%)*and rate return of S&P 500 index between 1/1940 (since inception) and 12/31/2007 = 68 years (9,10).


Table 56

Year

Average annual special-issue interest rates (%)

Effective annual interest rates (%)

Index Rate of Return with Full Dividend Reinvest-ment (%)
(Adjusted for Inflation)

Index Rate of Return without Dividend Reinves-tment (%)
(Adjusted for Inflation)

Annual divid-end of S&P 500 index
(%)

Annual infla-tion rate (%)

1940

2.5

2.4

-11.74

-16.90

5.16

1.57

1941

2.5

2.4

-20.95

-26.37

5.42

10.88

1942

2.2

2.3

6.64

-1.05

5.39

8.37

1943

1.9

2.1

17.38

11.51

5.78

3.23

1944

1.9

2.0

14.45

8.83

5.26

2.51

1945

1.9

2.1

33.90

28.28

5.72

2.45

1946

1.9

2.0

-28.23

-31.10

2.87

19.93

1947

2.0

1.9

-5.31

-10.00

4.69

9.68

1948

2.1

2.8

6.58

0.79

5.79

1.84

1949

2.1

1.3

18.16

10.42

7.74

-1.82

1950

2.1

2.0

18.81

10.94

7.87

6.98

1951

2.2

2.9

13.72

6.33

7.39

4.73

1952

2.3

2.2

13.95

7.49

6.46

0.82

1953

2.4

2.3

-1.22

-6.76

5.54

1.23

1954

2.3

2.3

49.74

42.53

7.21

-0.81

1955

2.3

2.2

34.92

29.75

5.17

0.41

1956

2.5

2.4

6.29

2.33

3.96

3.26

1957

2.5

2.5

-11.44

-14.88

3.44

3.17

1958

2.6

2.5

36.77

31.72

5.05

1.14

1959

2.6

2.6

8.51

5.18

3.33

1.51

1960

2.9

2.6

-0.69

-4.10

3.41

1.86

1961

3.8

2.8

24.87

21.26

3.61

0.73

1962

3.9

2.8

-8.36

-11.40

3.04

1.46

1963

3.9

2.9

16.94

13.33

3.61

1.80

1964

4.1

3.1

12.87

9.60

3.27

1.06

1965

4.2

3.2

8.09

4.92

3.17

2.10

1966

4.9

3.5

-14.23

-17.07

2.84

3.78

1967

5.0

3.8

13.95

10.43

3.52

3.32

1968

5.5

4.0

11.70

8.36

3.34

4.49

1969

6.6

4.4

-14.23

-16.95

2.72

6.45

1970

7.3

5.1

-2.07

-5.77

3.70

5.79

1971

6.0

5.3

6.25

2.97

3.28

3.57

1972

5.9

5.4

14.12

10.96

3.16

3.72

1973

6.6

5.8

-25.97

-28.20

2.23

9.25

1974

7.5

6.2

-37.24

-39.95

2.71

12.47

1975

7.4

6.6

21.21

16.20

5.01

7.14

1976

7.1

6.7

7.49

3.57

3.92

5.11


1977

7.1

7.0

-12.22

-16.09

3.87

6.73

1978

8.2

7.2

3.31

-1.84

1.47

9.11

1979

9.1

7.5

1.08

-4.06

2.98

13.49

1980

11.0

8.6

14.96

9.33

5.63

11.98

1981

13.3

9.9

-10.61

-15.01

4.40

8.81

1982

12.8

11.2

23.10

16.27

6.83

3.82

1983

11.0

10.8

15.83

10.95

4.88

3.91

1984

12.4

11.6

-0.25

-4.72

3.47

3.65

1985

10.8

11.2

23.23

18.24

4.99

3.94

1986

8.0

11.1

24.43

20.27

4.16

0.90

1987

8.4

10.1

-10.60

-13.23

2.63

4.13

1988

8.8

9.8

10.31

6.54

3.77

4.53

1989

8.7

9.6

22.89

19.02

3.87

4.51

1990

8.6

9.3

-5.35

-8.61

3.26

5.49

1991

8.0

9.1

21.97

18.13

3.84

2.68

1992

7.1

8.7

5.15

2.07

3.08

3.01

1993

6.1

8.3

8.09

5.15

2.94

2.45

1994

7.1

8.0

-3.88

-6.54

2.46

2.61

1995

6.9

17.8

35.70

32.40

3.30

2.32

1996

6.6

7.6

22.11

19.53

2.58

2.97

1997

6.6

7.5

28.53

26.32

2.21

1.51

1998

5.6

7.2

25.82

24.00

1.82

1.55

1999

5.9

6.9

14.21

12.82

1.39

2.66

2000

6.2

6.9

-11.82

-12.91

1.09

2.42

2001

5.2

6.6

-15.17

-16.30

1.13

1.00

2002

4.9

6.4

-22.04

-23.29

1.25

2.38

2003

4.1

6.0

22.90

20.82

2.08

1.56

2004

4.3

5.7

5.06

3.33

1.73

3.01

2005

4.3

5.5

5.67

3.84

1.83

3.49

2006

4.8

5.3

11.68

9.69

1.99

1.93

2007

4.7

5.3

1.91

0.11

1.80

4.11

Average
68 years
(1940 to 2007)

5.382%

5.488%

7.05%

3.10%

3.95%

4.08%

Average
68 years
Adjus-ted for inflation.

1.302%

1.408%

7.05%Adjusted for inflation

3.10%Adjusted for inflation

3.95%
Dividend

4.08%
Inflation rate.

*The average special-issue interest rate for a calendar year is the average of the 12 monthly interest rates on new issues during the year. An effective interest rate for a calendar year is the interest earned in that year divided by the average level of assets held during the year. This rate reflects the entire portfolio of securities held by the Social Security trust funds (OASI and DI). Effective rates for the trust funds on a combined basis are shown below; rates for each trust fund, separately, are also available. Table 68 shows the $ values when $250.00 is invested monthly ($3000.00/year) for 20, 30, 40, 50, 60 & 68 year at different rate of returns ( of SS and S&P 500 index) from last two lines of table 67.

Table 57

Rate

Amount in 20 Years

Amount in 30 Years

Amount in 40 Years

Amount in 50 Years

Amount in 60 Years

Amount in 68 Years

1.302%

68,818.75

110,404.95

157,770.63

211,719.00

273,164.88

328,415.29

1.408%

69,584.76

112,293.44

161,455.38

218,045.65

283,186.68

342,317.95

7.05%

132,044.94

310,078.48

669,648.55

1,395,863.63

2,862,582.84

5,055,353.12

3.10%

83,442.67

148,839.80

237,968.26

359,439.68

524,990.67

699,737.82

5.382%

108,147.87

224,650.31

423,969.78

764,977.66

1,348,394.71

2,101,908.41

5.488%

109,501.47

229,180.23

436,106.00

793,882.67

1,412,482.06

2,218,922.05

11.13%

222,459.00

728,244.63

2,259,714.22

6,896,854.95

20,937,665.25

50,835,873.41

7.18%

134,161.95

318,190.67

694,703.58

1,465,028.85

3,041,073.13

11,141,335.26

3.95%
Dividend only

91,730.36

172,790.37

293,036.53

471,412.29

736,018.74

1,037,192.85

Nowadays it is widely believed that "BUY AND HOLD for long time" strategy of stock investment does not work any more for various reasons. In view of the above facts presented, one should consider "buy and hold" as one of the investment strategies, which includes a diversified high dividend paying blue chip stocks in one's investment portfolio. One good place where a small investor can use the "buy and hold long time strategy" is with a diversified DRIP/s or DRP/s (Dividend Reinvestment Plan/s). Bad time or good time diversified DRIPs have one of the best amazing track records.
What is a DRIP?
DRIPs are investment plans offered by many publicly traded companies to its shareholders. A vast number of them are blue chip companies and pay good dividends year after year. One can find them out from the internet search engines or contact a broker. An investor needs to own only one or few stocks to enroll in a company’s DRIP. Once enrolled, the investor will no longer receive dividend checks. Instead, the company will reinvest the dividends, purchasing additional shares of company stock for the shareholder with or without charging a small commission.
Why reinvest dividends?
According to The Motley Fool Web article, Investing Through DRIPS - What Are Dividend Reinvestment Plans (DRPs)?, the advantages of DRPs are as follows: You don't need a large amount of money to start. Usually owning one share is all that is required to enroll in a DRP. DRPs are a cost-effective way for Fools to put stock dividends to better use – purchasing more shares of the company -- than simply spending the money or having it sit in a money market account. Most DRPs allow dividends to be reinvested at no fee. Most companies allow investors to purchase additional shares through a Dividend Reinvestment Plan for nominal fees or often no fee at all. These stock purchase provisions, sometimes called Stock Purchase Plans (SPPs) or Optional Cash Purchase Plans (OCPs), allow an investor to send in as little as $10 to $50 at a time to purchase additional stock. About 100 companies have DRPs that allow investors to purchase stock at a discount to the current market price. These discounts can range anywhere from one to ten percent. DRPs "force" investors to buy stock on a regular basis and hold on to that stock.
As a result, investors adopt a long-term horizon and often invest small amounts of money on regular basis-- money that they usually don't even miss. Nearly 200 companies also offer the option to make periodic DRP investments through automatic debits from bank accounts.
Source: Investing Through DRIPS - What Are Dividend Reinvestment Plans (DRPs)?, Jun 4, 2009 10:04 PM ET, The Motley Fool. http://www.fool.com/school/drips.htm
Critics of DRIPs support the fact that an investor may pay a higher price for new stock because he/she has no control over when the company will make the purchase. As with any financial decision, an investor would be wise to become familiar with the advantages and disadvantages of DRIPs before making an investment. The articles listed below present both sides of the investment opportunity.
Recommended Readings:
DRIP Investing, Step by Step: A Complete Guide to Investing in Stock on a Shoestring Budget by Doug Gerlach. DRIP Central. June 04, 2009. http://www.dripcentral.com/onlinebook/dripguidecontents.shtml
DRIP Portifolio – How a Fool Can Invest in Drips, Jun 4, 2009 11:22 PM ET, The Motley Fool. http://www.fool.com/DRIPPort/HowToInvestDRIPs.htm
The DRIP Portfolio: Disadvantages of Drips? Says who? Your broker? By George Runkle (TMFRunkle), Jun 6, 2009 2:54 PM ET, The Motley Fool. http://www.fool.com/dripport/1999/dripport990322.htm
(Untitled Article) Personal Financial Planning: Investment Opportunities Through Dividend Reinvestment Plans by J. Richard Williams and Debra Hall Oden, Southwest Missouri State University. The CPA Journal. July 1997. http://nysscpa.org/cpajournal/1997/0797/depts/pfp.htm
DRIPs have been likened to "Dollar-Cost Averaging (DCA)," a strategy of buying stock on a regular schedule over an extended period of time. Theoretically, DCA reduces "market risk," which is the potential to lose money due to day-to-day fluctuation in stock prices. As with DRIPs, there are proponents and opponents of DCA. To read an article in favor of DCA, go to the link below:
Dollar Cost Averaging: A Technique that Drastically Reduces Market Risk by Joshua Kennon, About.com: Investing for Beginners. June 6, 2009. http://beginnersinvest.about.com/cs/newinvestors/a/041901a.htm
To read an article against DCA, go to the following website: Dollar Cost Averaging Myths written by Andy on Wednesday, January 7, 2009. SAVING TO INVE$T: Smart Personal Finance and Effective
Investing in Today’s Economy. http://www.savingtoinvest.com/2009/01/dollar-cost-averaging-myths.html
To truly appreciate the amazing benefit of DRIPs, the full amount of the dividends received must be reinvested. Even larger accumulation of wealth occurs if some one keeps adding small amounts of principal frequently, such as dollar cost averaging.
Calculations are done on this site from mutualfunds. about.com (11).

References:
      Dow Jones Industrial Average: Accurate Index To Follow? cited from
The Dow Jones Industrial Average: The Impact of Fixing Its Flawshttp://www.mymoneyblog.com/archives/2007/09/dow-jones-industrial-average-accurate-index-to
follow.html
Ref: 2. Saturday, January 19, 2008 Why dividends matter?
http://www.dividendgrowthinvestor.com/2008/01/why-dividends-matter.html
3. Friday, August 15, 2008 Dow 370,000
http://www.dividendgrowthinvestor.com/2008/08/dow-370000.html
4. 5 blue-chip picks to beat the bear By Jim Jubak MSN Money
http://articles.moneycentral.msn.com/Investing/JubaksJournal/5-blue-chip-picks-to-beat-the-bear.aspx?page=1
5. Reinvestment is key to long-term growth. By Barbara Pietrowski –
Special to the Times
http://www.navytimes.com/money/financial_advice/ONLINE.INVEST.REINVEST/
6. Nightly business report interview of Jack Bogle, Founder of the Vanguard Group, Thursday, December 18, 2008. http://www.pbs.org/nbr/site/onair/transcripts/081218c/
7. Tuesday, December 16, 2008 Best Dividends Stocks for the Long Run
http://www.dividendgrowthinvestor.com/2008/12/best-dividends-stocks-for-long-run.html
8. Mentioned by Charles B. Carlson in The 60 Second Investor, page 31, 1992.
9. Average and Effective Interest Rates
http://www.ssa.gov/OACT/ProgData/annualinterestrates.html
http://www.ssa.gov/OACT/ProgData/intRates.html

10. Political Calculations:
http://politicalcalculations.blogspot.com/2006/12/sp-500-at-your-fingertips.html
11. Calculation by using the site’s calculator.
http://mutualfunds.about.com/gi/dynamic/offsite.htm?zi=1/XJ&sdn=mutualfunds&cdn=money&tm=264&gps=99_1092_1020_587&f=11&su=p649.0.147.ip_p284.5.420.ip_&tt=2&bt=1&bts=0&zu=http%3A//www.tcalc.com/tvwww.dll%3FSave%3FCstm%3Dfundadvice%26IsAdv%3D0%26SlvFr%3D6
Suggested readings:
Why Dividends Matter. http://www.buyupside.com/dividends/whydividendsmatter.htm
Payback Period - Buy Stocks with Increasing Dividends.
http://www.buyupside.com/articles_other/dividendpayback.htm
Dividend Aristocrats Can Soften the Blow of a Down Market.
http://www.buyupside.com/dividends/dividendaristocratssoftendownside.htm
Dividends Will Reward the Patient Investor.
http://www.buyupside.com/articles_other/dividendsrewardpatientinvestor.htm
A Dividend Stock That Will Set You for Life? By James Early
http://www.fool.com/investing/dividends-income/2008/01/07/a-dividend-stock-that-will-set-you-for-life.aspx
=========
Stock Dividends Make a Difference (Stock Dividends Make a Difference) by Dave Kansas
Monday, August 10, 2009

provided by THE WALL STREET JOURNAL
http://finance.yahoo.com/retirement/article/107502/stock-dividends-make-a-difference.html?mod=retire-planning
The article discussed both advantages and disadvantages of investing in dividend paying stocks.
stocks.

Further Readings:

The real reason buys and holds is dead- More "Boom and Bust" Cycles Coming: The Real Reason Buy and Hold Is Dead

Posted Mar 29, 2010 09:01am EDT by Aaron Task in Investing, Recession

"You don't have to be a mad scientist," he says; just "back off your risk in the stock market and buy bonds" if a recession appears imminent. "And if we see a recovery take more exposure and get out of bonds because the recovery is going to give you a little inflation."

http://finance.yahoo.com/tech-ticker/more-%22boom-and-bust%22-cycles-coming-the-real-reason-buy-and-hold-is-dead-453648.html;_ylt=Anw5OCmN4Cij4lY.uNYrYA.7YWsA;_ylu=X3oDMTE2djNuY3VkBHBvcwMxMARzZWMDdG9wU3RvcmllcwRzbGsDdGhlcmVhbHJlYXNv?tickers=%5EDJI,%5EGSPC,SPY,DIA,UUP,TBT,QQQQ&sec=topStories&pos=8&asset=&ccode=

Comment of the author: If invested in high yearly increasingly dividend paying blue chip stocks, as discussed in this chapter, the "buy and hold" strategy should work, provided invested for long time, must reinvest all dividends and keep adding small amount of new money all the time ignoring the market status, preferably along with the long time up trend such as 200 days moving average. This is discussed in the Chapter xx , page .

This is an idea only, not a recommendation.

5 blue-chip picks to beat the bear
By Jim Jubak
MSN Money

The Dow Jones Industrials vs. the Dow Jones Industrial Average
by RB Shaw - 1955 - Cited by 3 - Related articles
learn that the true performance of the Dow Jones indus- trials in the twenty-five year period 1929-1955 has considerably bested the "Average. ...
www.jstor.org/stable/4468541

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While Struggling to Consistently Make a Profit Selling Covered Calls in this Volatile Market, I discovered...

 

 

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