Rule of 72 and Investing
Rule of 72 and investing. I have previously written an in-depth article on What is the Rule of 72. I covered in detail the history and who invented the Rule of 72. I also discussed the derivation of the Rule of 72 as well as the modifications to the Rule of 72. Depending on the annual compounding fixed interest rate you should use the Rule of 69.3 to the Rule of 76. That pretty much covers fixed interest rates ranging from 1% to 20%, which for practical purposes covers interest rates for most investments. The Rule of 72 can quickly determine the number of years for an investment to double using an annual fixed interest rate. This makes it easy to use for savings accounts, CDs, bonds, and the like. But how do you use the Rule of 72 for investing?
Rule of 72 is Not Used Correctly
The Rule of 72 is often misunderstood and misused in investing. Many financial bloggers make the mistake of using the Rule of 72 to estimate the number of years that an investment will double in the stock market. They do this by assuming a rate of return. However, this approach to applying the Rule of 72 is not completely accurate.
First, the Rule of 72 must be used with an annual interest rate. It is not as accurate when compounding an interest rate monthly, daily, or continuously. However, in this case the Rule of 72 can be modified. Check my article above to find out how.
Second, the Rule of 72 is most accurate when the annual interest rate is between 6% and 10%. Outside of this range, it needs to be modified.
The most glaring mistake though is that investors often use the Rule of 72 utilizing trailing average total returns in the stock market instead of a fixed interest rate. This approach makes a big assumption that the price appreciation part of total return due to earnings growth or expansion of P/E multiple is fixed. That is obviously not the case. It also assumes that the dividend yield component of total return is fixed. We all know that total return are not constant and past returns doesn’t always equate to future returns.
Using the Rule of 72 in a Dividend Portfolio
It is possible to use the Rule of 72 for your dividend portfolio. This is possible if you actively manage your portfolios total yield. For example, if you try to maintain a roughly 3% dividend yield then you know the dividend income will double every 24 years. Seems like a very long time. From this perspective you would want a higher dividend yield portfolio to reduce time to a more reasonable number. If your average portfolio dividend yield was held constant at 6% then you are looking at 12 years to double your income. There are investors who use this approach.
But what about from the perspective of a dividend growth portfolio. What if you had a 3% average portfolio dividend yield and the dividend was growing. Clearly the dividend income will double faster because of dividend growth. Let’s examine Proctor & Gamble (PG) as an example. Proctor & Gamble is one of the safest Dividend Kings. Let’s assume that we buy $10,000 of stock on January 1, 2011. In the first year you would have $258.32 in dividends. Ten years later in 2021 you would have already received $403.43 in dividends to date and are on track to receive roughly $543 in dividends. You have more than doubled your income in 10 years due to the initial yield but also dividend growth.
Final Thoughts on the Rule of 72 and Investing
In the past decade Proctor & Gamble has raised the dividend at approximately 5.16% CAGR. So, it does not take too much dividend growth to double your income in 10 years. If the dividend growth rate is even higher then your income doubles more quickly. Hence, creating a portfolio of dividend growth stocks that is growing the dividend at a reasonable mid-single digit growth rate can lead to a rising passive income stream that can add to distributions from your retirement savings and your social security. Everyone has concerns about their retirement savings running out. Building a passive income stream that does not drawdown principal can at least potentially meet a part of your retirement income needs.
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Chart or Table of the Week
Today I highlight Walgreens Boots Alliance (WBA). The dividend yield has risen over 4% again since the stock price has fallen about 15% since mid-June. This largely coincides with Amazon’s announcement that it is evaluating entering physical drug store retail space. Walgreens is a Dividend Aristocrat having raised the dividend for 46 consecutive years. It is very likely that the Walgreens will become a Dividend King. The most recent quarterly dividend increase was 2.1%. Walgreens has also paid a dividend for more than 88 years. The current payout ratio is about 40%, which is conservative. The stock is trading below fair value. The screenshot below is from Stock Rover*.
Dividend Increases and Reinstatements
I have created a searchable list of dividend increases and reinstatements. I update this list weekly. You can search for your stocks by company name, ticker, and date.
Dividend Cuts and Suspensions List
I updated my dividend cuts and suspensions list at end of June. The number of companies on the list has risen to 526. We are well over 10% of companies that pay dividends having cut or suspended them since the start of the COVID-19 pandemic.
There were three new companies to add to the list this past month. These three companies were DTE Energy (DTE), National Health Investors (NHI), and Gap (GPS).
Dow Jones Industrial Averages (DJIA): 35,062 (+1.08%)
NASDAQ: 14,837 (+2.84%)
S&P 500: 4,412 (+1.96%)
The S&P 500 is trading at a price-to-earnings ratio of 46.9X and the Schiller P/E Ratio is at about 38.7X. These two metrics up this past week. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively.
I continue to believe that the market is overvalued at this point. I personally view anything over 30X as overvalued based on historical data. Note that we are near or over 40X and valuation levels near the top of the dot-com era.
S&P 500 PE Ratio History
Shiller PE Ratio History
Stock Market Volatility – CBOE VIX
The CBOE VIX measuring volatility was down over 1 point this past week to 17.20. The long-term average is approximately 19 to 20.
Fear & Greed Index
I also track the Fear & Greed Index. The index is now in Fear at a value of 32. This is up 9 points this past week.
There are seven indicators in the index. They are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.
Market Momentum is indicating Greed. The S&P 500 is 7.71% over its 125-day average. This is further above the average than normal over the past 2-years.
Junk Bond Demand is indicating Greed. Investors are accepting 2.01% yield over investment grade corporate bonds. The spread is down further from recent levels indicating that investors are taking on more risk.
Market Volatility is set at Neutral. The CBOE VIX reading of 17.20 is a neutral reading.
Safe Haven Demand is in Fear. Stocks have outperformed bonds by 1.61% over the past 20 trading days. This is still close to the weakest performance for stocks over the past 2-years as investors move back into bonds.
Put and Call Options are signaling Extreme Fear. In the last five trading days, put option volume has lagged call option volume by 51.51%. This is still amongst the highest level of put buying in the past two years.
Stock Price Strength is signaling Extreme Fear. The number of stocks hitting 52-week highs compared to those hitting 52-week lows is at the lower end of its range.
Stock Price Breadth is indicating Extreme Fear as declining volume is 6.71% more than advancing volume on the NYSE during the last month. This indicator is near the lower end of its range over the past two years.
The U.S. Census Bureau reported new residential building permits were down 5.1% in June to a seasonally adjusted 1.598M, 23.3% above the June 2020 rate of 1.296M. Single-family permits were up 6.3% over a revised May figure of 1.134M. Privately-owned housing starts were up 6.3% (the highest rate in 3 months) to 1.643M, 29.1% above the June 2020 rate of 1.237M. Single-family housing starts were also up, coming in at 1.160M, 6.3% above May’s revised 1.091M. All regions saw new residential building permits drop. The Northeast led the way at a seasonally adjusted -8.3% over May, followed by the West -7.4%, the Midwest -6.7%, and the South -6.0%.
The Labor Department reported higher initial jobless claims for the week ending July 17th. The seasonally adjusted initial claims came in at a 2-month high of 419,000, an increase of 51,000 from the previous week’s upwardly revised level. The four-week moving average, which smooths out volatility was 385,250. There were increases in filings in California, Illinois, Kentucky, Michigan, Missouri, and Texas.
The National Association of Realtors reported that sales of existing homes grew 1.4% in June to a seasonally-adjusted annual rate of 5.86M, up 22.9% as compared to June 2020. This follows four consecutive months of decline. Sales of single-family homes fell to a 5.07M annual rate (+24.4% Y/Y) while existing condo sales reported a 720K annual rate (+56.5% Y/Y). Total housing inventory reported in at 1.25M, up 3.3% over May’s inventory (-18.8% Y/Y). Properties typically remained on the market for 17 days, unchanged from May. Eighty-nine percent of the homes sold in June 2021 were on the market for less than a month. The median sales price increased to $350,300 (+23.6% Y/Y). The median existing single-family home price was $363,300 in June (+23.4% Y/Y) while existing condo price was $311,600 (+19.1% Y/Y). Regionally the South reported no change in existing-home sales while all other regions showed increases; Northeast (+2.8%), Midwest (+3.1%), and the West (+1.7%).
Thanks for reading Rule of 72 and Investing – Week in Review!
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