Get
an Early Start for a Richer Life
By James K. Glassman
"When
my grandmother died," wrote Jacob Woolston, a fifth-grader in
Brunswick, Mo., "she left me some money, and my mom and I invested
it in mutual funds. She told me it is earning about 20 percent per
year. I'm not exactly sure what that means, but my mom seems pretty
happy when she is telling me this."
Well,
Jacob, let me tell you what it means.
If
your grandmother left you $5,000, and it continues to earn 20 percent
a year, then, by the time you graduate from high school, you will
have $18,000. If you can keep it invested, then, when you graduate
from college, you will have $37,000. When you are 30 years old,
you will have $268,000. When you're 50, you'll have $12 million,
and when you're 65, you'll have $189 million.
Alas,
nothing grows at 20 percent forever--but if you have something that
is growing at 20 percent right now (for example, a portfolio of
stocks), then relax and enjoy it. The miracle of compounding is
beautiful to behold.
Jacob
Woolston is one of nine winners in the Stein Roe Young Investor
Essay Contest, in which fifth- through seventh-graders were asked
to express their views on money and investing in 250 words or less.
Molly Eaton of Oshkosh, Wis., for instance, told how she was setting
up a business to paint reflective house numbers on street curbs,
socking away the profits in Stein Roe Young Investor Fund (1-800-403-5437).
As
a winner, she gets more shares in the fund, which gives young people
a taste of finance through kid-oriented newsletters and earns them
money through a portfolio that includes stock in companies they
probably know, such as McDonald's Corp. (MCD) and Walt Disney Co.
(DIS).
And
Jacob's mom is right: Over the past three years, the fund has returned
an annual average of 24 percent. But Jacob and Molly can't count
on this kind of performance for the next 40 years.
Still,
even if an initial investment of $5,000 grows by 11 percent annually--the
average over the past 72 years--it becomes $1.6 million by the time
Jacob is 65.
The
point is that in investing--as in so many other endeavors--the young
have a huge advantage. Start early with a little money and you can
build a gigantic nest egg. Start late with a lot of money and you
can't catch up.
Consider
an investment that returns 15 percent annually (or three percentage
points less than the average return of the Standard & Poor's
500-stock index for the past 20 years). If you put away $10,000
when you're 25 years old, you'll have $1,332,000 by the time you're
60. But if you wait until you're 40 years old and invest $50,000
at the same return, you'll accumulate only $818,000.
More
young people than ever are getting into the stock market, but unfortunately,
many of them see it as a casino in which they have to place the
right bets, grab their winnings and put them down on something else
that will soar in price. They are dazzled by Internet stocks, and
no wonder. It has been quite a thrill, over the past year, to watch
$1,000 invested in America Online Inc. become $5,337.
But
the truth is, volatile high-tech stocks are more suitable for older
investors who have waited so long that the only way they can build
a decent retirement account is to trust the luck of the Internet
lottery.
Young
investors, with time on their side, have the luxury of profiting
handsomely with a solid portfolio of consistent growers. After all,
says Richard Meagley, "Ten percent compounded over 20 years
is a lot of money. I wish someone had tried to convince me of that
when I was 20 years younger."
Meagley,
at age 43, is now in the business of trying to increase other people's
money at a nice clip over 20 years or more. He runs Safeco Equity
No-Load (1-800-426-6730), which has returned a lot more than 10
percent--25 percent, to be exact--since he's been manager.
In
fact, Meagley has a record of consistency like none I have ever
seen. He took over the fund in 1995 (after laboring in other Safeco
fields since 1983) and that year produced a return of 25 percent.
In 1996, his return was also 25 percent; in 1997, it dipped to 24
percent; then, in 1998, it was 25 percent again. So far this year,
the fund is up 10 percent, or roughly (you guessed it) 25 percent
on an annualized basis.
There
are no guarantees this will continue, of course, but the fund receives
top ratings from both the major mutual-fund research services: five
stars from Morningstar and "1" from Value Line. Its expense
ratio is less than 1 percent, and the minimum investment is $1,000.
The fund is fairly concentrated--40 to 50 stocks, with the largest
holding representing just 3.4 percent of total assets. Over the
past 10 years, Safeco Equity ranks sixth among 150 funds tracked
by Lipper Inc. It sounds almost too good to be true.
You
don't have to buy the fund to benefit from Meagley's approach. Just
watch how he does it. "We do two things," he says. "We
own better-quality companies, and we don't change things around
a lot."
He
looks for firms that have reliable earnings--that is, profits that
he can reasonably predict five years out. If the price is attractive
enough, the earnings don't have to be zooming along at 20 percent
annually. He buys and holds. The fund's turnover rate is 35 percent,
meaning he keeps the average stock for three years (nearly three
times as long as the typical manager). Of his 10 largest stocks
at the end of 1998, eight were in the fund at the end of 1997.
"If
you can find something that can grow at 10 percent to 20 percent
for as far as the eye can see," he says, "then you can
buy it and hold it." He cites Fannie Mae (FMN), the giant mortgage-financing
firm, and Johnson & Johnson (JNJ), the health-products company.
Fannie is expected to increase its earnings at 15 percent annually
over the next five years, according to Value Line; J&J, at 13
percent. Again, there are no guarantees, but these are superbly
run companies with solid histories.
Such
rapid growth isn't a requirement. Take Emerson Electric Co. (EMR),
one of the stocks Meagley bought in the first quarter of this year.
"Growth of 8 percent going forward works for me," says
Meagley, with a stock that has a relatively modest price-to-earnings
ratio of 19. Emerson's earnings for the past year were $2.87. At
a growth rate of 8 percent, they will hit $4.22 in 2004.
If
the stock trades at $100 in that year, its P/E will be less than
24 ($100 divided by $4.22 equals 23.7). That's not especially high.
Meanwhile, Emerson is paying a dividend of $1.30 a year. If the
payout, too, grows at 8 percent, it will become $1.91.
Will
Emerson achieve that kind of growth? One indication, says Meagley,
is that its earnings have risen for 40 straight years.
So
far, he seems to have made a good choice. Between April 5 and May
6, Emerson, which makes prosaic industrial motors, jumped from $51.44
to $68.81.
His
top holding, Kimberly-Clark Corp. (KMB), has been increasing its
earnings at about 12 percent annually and has risen since February
from $45.75 to $61, trading at a P/E of 23 (based on last year's
earnings) with a dividend yield of 1.7 percent, compared with an
average P/E of 34 and yield of 1.2 percent for the S&P 500.
Another
first-quarter purchase, Gannett Co. (GCI), has numbers similar to
Kimberly-Clark's--a growth rate of 12 percent and a P/E of 24, with
a stock that has languished until lately. In the past month, it
has risen from a low of $62 to a high of $75.44.
But
Meagley is not a value manager. His number-two holding is Microsoft
Corp. (MSFT)--not inappropriate for a fund that has been headquartered
in Seattle since 1933. He also has large stakes in Intel Corp. (INTC)
and drugmakers such as Abbott Laboratories (ABT), American Home
Products Corp. (AHP) and Merck & Co. (MRK).
Since
stock prices are directly correlated to earnings, a company that
compounds its earnings at an impressive rate will compound its price
at something close to that rate as well.
For
that reason, young investors should be long-term partners in companies
such as Fannie Mae, Emerson and J&J, rather than short-term
speculators in flashes in the high-tech pan.
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