There are many ways to build wealth, and everyone who has amassed a fortune has their preferred method. Sometimes it involves real estate development. Other times, an investor lucked into getting in on a high-growth stock early. However, in a vast majority of cases, success is a simple matter of discipline and determination.
The sort of real estate projects that create billionaires like Stephen Ross (net worth $7.6 billion), Sun Hongbin (net worth $9.2 billion), and Donald Bren (net worth $15.5 billion) are out of reach for average investors. They require massive amounts of capital up-front, as well as the ability to absorb significant risks.
Choosing the next Amazon (AMZN), Apple (AAPL), Google (GOOG), or Microsoft (MSFT) when shares first become available is an equally unreliable strategy. It can happen, but most investors don’t hit millionaire status that way.
The most dependable method of realizing long-term portfolio growth is the one championed by the “Oracle of Omaha” Warren Buffett. It relies on making regular investments in high-quality companies, then leaving them untouched while time creates long-term returns through compounding.
Dividend Stocks Compound Wealth Over Time
The concept of compounding is simple. You invest, and the investment generates returns. Then, the returns are added to your principal, and the entire amount generates additional returns. Given enough time, you can create substantial wealth through the magic of compounding.
It’s a common misconception that compounding only applies to traditional banking products like savings and money market accounts. It’s true that these accounts generate interest and that interest compounds over time. However, the issue banking customers run into when relying on their savings and money market accounts for interest is that rates are too low to match inflation.
Even when savings accounts are left untouched for decades, it is more likely than not that you will lose buying power – compound interest notwithstanding.
The magic of compounding returns is enhanced through investment in dividend stocks. As dividends are paid, you can reinvest them, creating the perfect scenario for compounded returns. Though it is impossible to predict the future of a specific stock, history indicates that the market as a whole will grow.
Between 1926 and 2019, the market averaged 10 percent annual returns. When inflation is considered, this figure comes in at a solid 6 percent to 7 percent. Of course, most years are much higher or much lower, which is why time is so critical to success.
Regular reinvestment of dividends and long-term market growth create compound returns that can transform average investors into millionaires.
Warren Buffett’s Coca Cola Purchase: A Case Study In Compound Interest
Warren Buffett has mastered the art and science of building wealth through compound interest. One of the most compelling examples of his strategy is his investment in and commitment to the Coca-Cola company.
In 1988, Buffett put more than $1 billion into Coca-Cola (KO) through his holding company, Berkshire Hathaway.
Share prices were down after the 1987 market decline, so he was able to get the stock at a discount. At the time, his investment gave Berkshire Hathaway a 6.2 percent ownership stake in Coca-Cola. He grew his position in Coca-Cola in the years that followed, and today, Berkshire Hathaway owns approximately 400 million shares.
Buffett’s Coca-Cola stock has a cost basis of just $3.25 per share. However, Berkshire Hathaway gets an annual dividend of more than $1.50 per share – or roughly $672 million per year.
As a result, Berkshire Hathaway is paid over 40 percent of the original cost basis each year – and all Buffett has to do is hold onto his current position.
The dividends offered by Coca-Cola might have been small when Buffett first invested, but in the decades that followed, they have compounded. Stock splits helped this process along, as did the consistent increase in the company’s overall value.
The Single Most Important Quality To Compound Wealth
The takeaway from careful examination of Warren Buffett’s Coca-Cola strategy is that patience is the single most important quality to compound wealth.
Buffett didn’t enjoy massive payouts on his principal in year one or year two. Even year ten was nothing particularly impressive.
But now, more than 30 years later, Buffett’s patience has paid off in a major way.
His initial investment compounded over time, contributing to his transformation from an average investor to an extraordinary one.
Best Stocks for Compound Interest
Of course, not every stock will deliver the extraordinary results that Warren Buffett realized with Coca-Cola.
In fact, Coca-Cola itself might not offer the same returns in the coming decades as it has in the past. However, with a bit of research, you can choose the likeliest candidates to create long-term returns.
Prioritize stocks that are committed to paying dividends. If you don’t have a favorite, review the elite group of Dividend Aristocrats – companies that have increased dividends for 25 or more consecutive years. Five examples include the following:
- 3M – 63 consecutive years of dividend increases
- Cincinnati Financial – 61 consecutive years of dividend increases
- Kimberly-Clark – 49 consecutive years of dividend increases
- Sherwin-Williams – 42 consecutive years of dividend increases
- Stanley Black & Decker – 53 consecutive years of dividend increases
The key is to choose dividend-paying stocks from a diverse selection of reliable companies, then ignore the ups and downs of the market. Give your investment time to grow.
A Final Note on Building Wealth
If you aren’t quite sure which companies have the best stocks for compound interest, consider an alternative solution – also taken from Warren Buffett’s playbook. Buffett suggests that the best choice for average investors is an S&P 500 index fund.
This type of investment gives you exposure to the majority of the market, which means instant diversification in every share. As discussed, the stock market has historically gone up, which puts you in a solid position to escape the risk of inflation.
The author has no position in any of the stocks mentioned. Financhill has a disclosure policy. This post may contain affiliate links or links from our sponsors.