The Four Key Ingredients You Need To Build Long-Term Wealth

Would you like to learn the secret to successful investing?

It’s pretty simple. The secret is thinking long term.

The great fortunes of the world weren’t created by buying and selling stocks every few months, or buying and flipping houses.  The Kennedy, Rockefeller, Carnegie, and Ford fortunes were built first from businesses, but nurtured through long-term investing over decades and centuries.

Long-term investing lets you harness the power of four key ingredients that are necessary to build wealth.

But before we get into the four ingredients, let’s talk a bit about short-term investing and why it doesn’t usually lead to building wealth.

Short-Term Vs. Long-Term

Not all investments are designed to be held for a long time.  So of course short-term investing strategies have their place in an investor’s toolkit of strategies.

Sometimes a short-term investment is the best course of action.  But more often than not, short-term thinking creates losses or missed opportunities for investors.

Why?  Because it introduces emotions into the picture, and emotions and money do not go well together.

Part of the reason short term investing is so common is that human beings are wired to think and act in the short term.  Maybe our preference for short-term results harks back to caveman days, when what only mattered was finding food, shelter, and fire to make it through each day.

While our instincts work to protect us in the short-term, they are largely driven by emotions such as fear and greed.  And when it comes to money, mixing money with emotions will usually cause you to do the wrong thing at the wrong time:

  • You’ll buy when you should be selling.
  • You’ll sell when you should be buying.
  • You’ll take small short-term profits instead of large long-term ones.

In addition:

  • You’ll incur greater costs in terms of commissions and time spent looking for investments.
  • Taxes are usually higher on short-term investments.
  • The more investments you make, the greater the likelihood is of losing money.

So, whenever possible, think long term!

The Recipe For Financial Success

Long-term investing success makes use of four key ingredients:

  1. Time
  2. Dollar-cost averaging
  3. Compounding
  4. Tax Advantages

By investing long term, you get to put the power of all four to work.

However, if you set your sights on short-term investments, you don’t put any of these in your favor.

This seriously limits how much you can create with just a little money.

Let’s now go more in-depth on how each of these four ingredients can supercharge your long-term investing results.

1) Time

Time is the easiest factor to understand.  Time allows your investments to grow automatically through:

  • Inflation
  • The paying off of debt on assets

Inflation

The simplest definition of inflation is rising prices over time. Inflation is what causes rents, for example, to rise from $1,000 to $2,500 a month over the years or candy bars to rise from a nickel in the 1960s to over $1.00 today.

In actuality though, inflation is a complicated monetary phenomenon.

To keep things simple here, I won’t go into a discussion of why or how we have inflation – you’ll likely fall asleep.  Let’s just note that our federal government targets a 2% to 3% annual inflation rate, which means they hope to see prices of goods and services rise 2% to 3% each year.

The government directs its monetary policies to ensure that inflation slowly but surely brings about higher prices for just about everything.

Why would they do this?

There are many reasons, but the most powerful one is that it is much easier (and probably necessary) to pay off the current $18.278 trillion debt with dollars that are worth less in the future than they are today.  This makes our colossal debt much smaller and manageable.

Check out the live debt clock at: http://www.usdebtclock.org/ to see the current debt.

How Does Inflation Benefit You?

If you have a rental property with fixed expenses like a fixed-rate mortgage, your income and profit rises slowly but surely over the years because your biggest expense – the mortgage – doesn’t rise while rents slowly do rise.

And in the case of rental properties bought with borrowed money, eventually your tenants end up paying off your mortgage.  Now you have a paid-for asset that puts more money in your pocket each month now going forward.

2) Dollar-Cost Averaging

Dollar-cost averaging is the second power ingredient.  It is simply the process of purchasing something at regular intervals.  Doing so has you buying more of the investment when prices are low and less of the investment when prices are high.

A great example is buying stocks in your retirement account every month.   Dollar-cost averaging automatically kicks in, and over time you end up buying more shares at a lower price and less shares at a higher price.  The result is a better overall return than if you bought everything at one time.

Dollar-cost averaging is mainly used for ongoing purchases of paper assets like stocks or bonds, but it can also apply to ongoing purchases of gold and silver coins.

3) Compounding

Compounding is the next secret to long-term wealth.

Compounding has been called the royal road to riches. It is simply the process of reinvesting the income from an investment so that the income also generates its own income.

All you need is an investment that pays income at a decent rate and a long-term time horizon.  The math will do the rest.

Dividend-paying stocks are an ideal asset to employ compounding.

You simple use the dividends that a stock pays you each quarter to buy more shares of the stock.  The result is that you slowly but surely increase the number of shares that you own. Done over a long period of time, you can end up with many multiples of the number of shares you started with.

Dollar-cost averaging also enters the picture here, so you end up buying more shares when the price is low and less when the price is high.

Compounding with dividend-paying stocks can automatically give you a huge return on your original investment. If you compound long enough, the compounding effect becomes so powerful that you’ll be accumulating much more money each month than the original cost of the stock.

The key is to start early and let compounding work its magic for many years. The earlier you start, the more money you can accumulate effortlessly. The results after 20 to 30 years grow exponentially.

Let’s look at a compounding chart over 40 years.

This chart shows the investing results of Gary and Jane.  Jane’s results are in green and Gary’s results are in black.

Both of them invested $1,000 a month until they reached age 65.  The only difference is that Jane started at age 25 while Gary started at age 35.

The difference of those 10 years?  Gary ended up with $1.5 million.  But Jane ended up with $3.5 million.  The results start to dramatically increase at the 30-year mark.

Compounding Quiz

Let’s do a simple quiz:

What would you choose: A) to receive a million dollars in one payment, or B) to receive a penny doubled every day for 30 days (one penny on day 1, two pennies on day 2, four pennies on day 3, etc.)?

Most people would immediately think the million dollars upfront was the better choice, but here is what the math looks like with the penny-doubling scenario:

Day 1: $0.01
Day 2: $0.02
Day 3: $0.04
Day 4: $0.08
Day 5: $0.16
Day 6: $0.32
Day 7: $0.64
Day 8: $1.28
Day 9: $2.56
Day 10: $5.12
Day 11: $10.24
Day 12: $20.48
Day 13: $40.96
Day 14: $81.92
Day 15: $163.84
Day 16: $327.68
Day 17: $655.36
Day 18: $1,310.72
Day 19: $2,621.44
Day 20: $5,242.88
Day 21: $10,485.76
Day 22: $20,971.52
Day 23: $41,943.04
Day 24: $83,886.08
Day 25: $167,772.16
Day 26: $335,544.32
Day 27: $671,088.64
Day 28: $1,342,177.28
Day 29: $2,684,354.56
Day 30: $5,368,709.12

That’s quite a difference, wouldn’t you say?

Here is another example of long-term compounding with a dividend stock:

$1,000 investing in Philip Morris stock in 1925 would be worth $250 million 80 years later!

It is the magic of compounding that achieves such huge returns over time.

Now that you see the power of compounding, commit to getting started today, not tomorrow.  You’ve seen how just a few years can make a huge difference in your final result.  The earlier you start, the more powerful compounding becomes.

Long-Term Dividend Stock Investment Profile: Realty Income 

I’m going to give you an example here of a dividend-paying stock and the return it has created over the last 20 years.

Realty Income (Ticker symbol: O) is one of the largest and most respected real estate investment trusts (REIT). A REIT is a company that owns commercial real estate and leases it to other companies.

REITs pay shareholders dividends based on the revenue they receive from their tenants.

Realty Income owns more than 4,200 commercial properties that tenants rent on long-term leases. They pay a monthly dividend.

NOTE: I am featuring this stock only as an example of a dividend-paying stock. This is not a recommendation to buy this stock or any of their securities.   I also want to disclose that I am a shareholder in Realty Income for many years now.

Realty Income Dividend Increases

The chart above shows Realty Income’s dividend history.  It shows that they have had 81 dividend increases since they went public in 1994.  They have also had 71 consecutive quarterly increases in their dividend, which is something that few companies have been able to achieve.

The dividend increased from $0.90 a share in 1994 to $2.28 a share in 2015.  This shows that the company has been consistently making more money each year.  They couldn’t have increased the dividend all these years if they weren’t.

The Magic Of Rising Dividends Over Time

The next chart shows the magic of rising dividends over time.  Take a quick look at it, and I will summarize it in a moment.

The original $8,000 purchase has grown to $44,390 in about 20 years.  Plus, the original annual dividend of $900 has grown to $2,280.

The original $8,000 investment has yielded over $27,200 in dividends over the years.  That’s more than three times the original investment!

Now, these results are just from the one initial purchase of shares in 1994.  What happens if you were to compound the dividends over the years by buying more shares?  This is when it really starts to get interesting……

Compounded Results

$10,000 invested in Realty Income starting in 1996 would have purchased 889 shares.  By October 2014, this would have grown to 3,070 shares now worth $135,000 and paying a monthly dividend of $562.00!

All this from one $10,000 purchase!

Dividends + Compounding + Dollar Cost Averaging + TIME = Financial Freedom

If you combine dividends + compounding + stock splits with the final part of the equation – TIME, you can create some serious wealth….

  • The number of shares you own increases due to compounding the dividends into more shares of the stock
  • The dividends paid to you each quarter rises as the company makes more money over the years
  • The value of all your shares greatly increases over the years as the company grows and makes more money.
  • TIME makes it all happen: Allow your investment to grow over a period of 20 to 30 years or more for maximum results….

4) Tax Advantages

The final ingredient of long-term investing is the tax advantages granted to longer-term investments.

The biggest benefit is that investments held longer than one year are taxed at the long-term capital gains rate.

Currently, long-term capital gains are taxed at the following rates:

  • Individuals in the 0% to 15% tax bracket: 0% tax rate
  • Individuals in the 25% tax bracket: 15% rate
  • Individuals in the 39.6% tax bracket: 20% rate

Since the 15% tax bracket includes single filers with incomes up to $37,450 and married joint files with incomes up to $74,900, many people will not have to pay any tax on their gains!

The key is to hold your investments at least one year to qualify for long-term capital gains.

Summary

Long-term investing is one of the secrets to building sustainable wealth.

Most of the world’s wealthiest individuals hold their wealth in sustainable long-term investments, especially real estate.

Not only is long-term investing a lot less work, but you get time on your side, which is one of your best allies in reaching your financial goals.

Add in dollar-cost averaging, compounding, and tax advantages, and you will be on the fast track to wealth!

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