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Get Rich Slowly

Harness the Power of Compounding

Building wealth in the stock market is all about making regular periodic investments and reinvesting rather than spending the profits. Here’s how that works.

Say you start with nothing, but decide to put $500 of your income into an investment account every month, and you don’t take anything out until you’ve reached your long-term goal.

Power of Compounding
Later, I will give you a short list of mutual funds that have returned at least 10%, on average, annually, over the past 10 years. While no one can predict the future, should you achieve that same return, you’d have $103,000 after 10 years, $383,000 if you stick with the plan for 20 years and $1.1 million in 30 years. Of course, you’ll do even better if you increase your monthly investment as your earnings rise.

Discipline Required
The hardest part of achieving these returns is making the regular monthly investments. It’s easy to procrastinate adding to your account if the market is down or if you could use the cash for something else. It’s best to set up an account with a broker or mutual fund that automatically deducts a fixed amount from your bank account every month. Once you’ve selected your funds, don’t cherry pick. Start with equal dollar amounts of each fund, and then add to each fund equally every month.

Finding Funds
Here’s how to use Morningstar’s free fund screener (registration required)  to find suitable mutual funds. Start from Morningstar’s homepage (www.morningstar.com) by selecting Funds, and then Basic Fund Screener.

First, limit the field to U.S. stock funds by picking U.S. Equity in the Fund Group category, which rules out bond funds and funds focusing on foreign stocks.

Then, specify “10 years or longer” for Manager Tenure. Since, we’ll be using long-term returns to select funds, that data is meaningless if the manager responsible for the returns is no longer at the helm.

Next, specify a $3,000 maximum initial purchase requirement. Don’t be discouraged by the $3,000 minimum if you want to start smaller. Many funds have lower minimums for investors initiating automatic investment plans (AIPs), and after the initial purchase, most funds require minimum monthly additions between $50 and $250. You can find each fund’s minimum purchase requirements on Morningstar’s “Purchase Info” report.

Sales loads are commissions that mutual funds pay to financial advisors and others to recommend their funds. These commissions reduce your returns and there’s no point in paying them if you’re choosing funds on your own. Thus, require “no-load funds only.”

Morningstar rates funds based on their historical return vs. risk performance. The ratings vary from one to five stars, where five is best. This strategy hinges on picking the funds with the best historical records, so require “five-star funds only.”

Morningstar’s risk rating compares each fund’s historical volatility to similar funds. The ratings range from low to average to high. Avoid volatile funds by specifying “average or better” for risk rating.

Finally, limit the field to consistent winners by specifying that passing funds’ returns “equal or exceed” the S&P 500’s average annual returns over the past 3, 5 and 10-years.

Results
My screen turned up 13 funds, but some were duplicates and some were not widely available or closed to new investors (see Morningstar’s Purchase report), leaving six viable candidates. Here’s the list.

American Funds New Economy (RNGFX): Average annual 10-year return 10.7%. Minimum initial investment $250, minimum monthly addition $50.

Buffalo Discovery (BUFTX): Ten-year return 11.9%. Min. initial $100 (AIP), monthly $100.

First Eagle Fund of America (FEAFX): Ten-year return 10.4%. Min. initial $2,500, monthly $100.

Nicholas (NICSX): Ten-year return 10.6%. Min. initial $500, monthly $50.

Parnassus Endeavor Fund (PARWX): Ten-year return 12.1%. Min. initial $2,000, monthly $50.

T. Rowe Price Mid-Cap Growth (PAMCX); Ten-year return 11.6%. Min. initial $2,500. Monthly $100.

Eventually, some of these funds will change management, get acquired, etc. When necessary, use the Morningstar screen as described above to find replacements. 

published 5/29/15

 

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