When I was a child my parents told me a fairytale about a funny land over the horizon. In this land a fool plants small amounts of money into the soil and hopes that money trees grow producing big harvests of free money.
When I was young I was foolish enough to want to move to the funny land over the horizon where the money trees grew, naively believing that I could find these wonderful money trees and plant them in my own orchard.
Strangely, some aborigines of this land heard about money trees and a small fraction of them even tried to plant their money on these trees. But it seems that even the most enthusiastic planters did not fully trust the fairytale and lowered their expectations to only grow only 10% of their money on the wonderful money trees (see footnote 1).
Initially I thought that this made sense, and I joined the community of planters and attempted to seed the trees with small but growing money fruits.
Then recently I told my young four-year-old son the fairytale about a funny land over the horizon with free money on the trees. He asked me: "Dad - will I find such trees?" I said "Sure and I'll help you."
When I had excess money not needed for my sons "toys and candies" (see footnote 2) I started to invest my own money (mostly in mutual funds). However, it took me several years of intensive reading of finance literature and independent thinking (footnote 3) about stocks to prepare and become ready to help my son who is a bit older than 4 now. Now I am older and wiser as well and I feel it's time to suggest to my son that he not trust his hard-earned money to so-called certified financial pundits who I am convinced do not know any more about stocks and finance than I now do.
Let's quit fiction now and move on to the real world of finance and look at dividend paying stocks that I believe may be the closest thing to the fairy tale free money trees that exist in the real world. Here is a simple 7-step instruction how to plant real free money trees, better known as dividend growth stocks.
1) Diligently and methodically save a portion of your money (earnings)
2) Select solid companies with growing dividends and earnings
3) Plant a whole orchard, i.e. invest 3% or less of your money into any single company-in other words diversify (see footnote 4)
4) Hold until the price of any company's stock increases at least twofold (see footnote 5)
e) Sell half of any stock with 100% or higher gain
f) Enjoy the free money (dividends on zero cost) that grow on your free money trees (dividend growth stocks)
g) Always plant new trees in the spring (bear market) and harvest trees in the autumn (bull market)
Since I was wise enough to start young, some of my money trees (dividend growth stocks) are already bearing fruit (increasing dividends). Hopefully, my son will soon have his own orchard full of free money trees (dividend growth stocks) bearing succulent fruits (growing dividends). Hopefully, my little story of the free money trees will inspire some of you to plant your own money tree orchards. However, never forget that not all money trees bear fruit (sometimes you can lose your money), so be wise and diversify.
The author is grateful to Chuck Carnevale for proofreading.
1. These aborigines call the ripening fruit on the money trees growing dividends or yield on cost (YOC = increasing dividends/initial stock price) but some aborigines are so funny that they still endlessly debate current yield over yield on cost (see http://seekingalpha.com/article/383021-should-dividend-investors-care-about-entry-price#comment-2862141).
2. When I came to the funny land over the horizon (the zany world of finance) my knowledge about real world economics, finance and the stock market was the same as a newborn baby. I grew up quickly, studied hard, and after 4 years of my life in the funny land of finance,I applied my learned skills and started to invest.
3. Bertrand Russell, a famous British philosopher, logician, mathematician, historian, and social critic, might have been thinking about finance pundits when he wrote "Most people would rather die than think".
4. About 3% of Dividend growth stocks cut their dividends - see - see seekingalpha.com/instablog/725729-sds-se... so be prepared that some of your money trees maybe lemons.
5. I assume zero inflation and broker fees. For taxable accounts more than 2X price appreciation is needed.