This year I have written blogs to help explain cryptocurrencies and NFTs (Non-Fungible Tokens) to kids - in both cases I have stressed caution when thinking about these as investments, as they are very risky. This week, I spent some time with my daughters reminding them why we invest their money in the stock market, with a particular focus on the magic of dividend investing.
When explaining dividend investing to my kids, I went back to my trusted analogy of thinking of money like seeds.
Thinking of money like seeds (a quick recap)
If you’ve read my investment related blogs or my book, Grandpa’s Fortune Fables, you’ll know that I encourage my daughters to think of money like seeds. If those seeds are planted (invested) they will grow into trees, or ‘Blue Trees’ as my girls call them. Their goal is to grow their own financial forest.
My daughters know that investing in the stock market means that they own a small piece of hundreds of different companies. As these companies grow, then the money which they have invested, i.e. their Blue Trees, will also grow. This is the short version - you can read the full version about how I taught my daughters about the stock market here.
Do cryptocurrencies and NFTs fit into this tree analogy?
If we use the tree analogy, both cryptocurrencies and NFTs would need to be viewed as a new type of tree. These trees could potentially grow very large but these trees don’t produce any seeds. If you want to make money from these trees, you have to hope they grow, then chop them down (sell them) and find someone to buy it from you.
Owning these types of trees can be very stressful:
“When is a good time to chop the trees down?”
“Will the trees continue to grow in the future?”
“Will people even want these types of trees in the future?”
I certainly don’t like making these types of decisions and would prefer a much less stressful way of managing my money. This is why investing in the stock market is my preferred route - especially as you get DIVIDENDS.
What is a Dividend?
My daughters asked “What are these ‘seeds’ from our Blue Trees?”
To make it simple for them, I used McDonalds as an example.
When McDonald’s sells a Big Mac, it doesn’t keep all the money. It needs to pay for wages and rent. They also need to cover the cost of the ingredients for the Big Mac. After it’s paid for all the expenses then the money left is the PROFIT. McDonalds then needs to decide what to do with this profit.
There are generally three things McDonalds can do with their PROFIT:
Pay everyone who works there a bit extra that year as a thank you for their hard work, i.e. pay a BONUS.
They could use the money to open new restaurants or create new burgers to make even more money, which is called ‘REINVEST’.
Give money to the investors as a thank you for supporting the business - this is called a DIVIDEND!
Most companies do a combination of all three of the above. Although new companies (startups) look to reinvest their profits so they can grow more quickly so don’t pay bonuses or dividends.
A lot of companies pay out dividends every 3 months, although some pay them out monthly or every 6 months. The amount can vary depending on how much profit they have made. At the moment, the average you get is around 2% per year of the money you invested back as a dividend. This is more than you’d get from most bank accounts at the moment. That might not seem like a lot but over time the magic starts to happen.
Dividends grow over time
Remember, when you invest in the stock market, it’s like a tree growing. So if you invested £1000, in the first year you’d get around £20 in dividends. Over time your trees begin to grow, as the companies you invest in grow. As the tree grows, it produces more seeds. In 10 years, you could get double the amount in dividends, i.e. £40 per year, from your initial £1,000.
Let’s look at what could happen to these investments over time, assuming you spend the dividends you receive each year.
Spending your dividends:
Initial investment: £1,000
Size of investments after 30 years (estimated): £5,743
Total dividends received and spent: £1,581
Dividends paid out in year 30: £115
After 30 years, you could expect to have received over one and half times your initial investment back in dividends (£1,581) and still be receiving even more each year (over £115 per year).
This seems like a good investment, however, this is just the start. There is more magic. If you take those seeds (dividends) and use them to plant more trees (i.e. invest the dividend), these trees grow and produce even more seeds. This is called ‘reinvesting your dividends’.
Reinvesting your dividends:
Initial investment: £1,000
Size of investment after 30 years (estimated): £10,063
Total dividends received and reinvested: £2,266
Estimated dividends paid out in year 10: £201
This shows that by reinvesting your dividends, the initial investments have grown from £1,000 to over £10,000 after 30 years. Also, after this time, you could also be getting around £201 in dividends EACH YEAR which is equivalent to 20% of your initial investment.
For a lot of the investments my wife and I made many years ago, we have now received more in dividends than the amount of money we invested and they are still growing and producing more dividends.
The above is based on just investing £1,000 and no more. Imagine how much bigger the forests will grow, and how many more seeds it will produce, if you invest a regular amount each month.
No stress investing
I explained to my daughter that, unlike ‘investing’ in cryptocurrency or NFTs, we don’t have to worry about when to chop down our trees (sell our investments) as we have no intention of ever chopping down our blue tree forest (selling our shares). We simply want to keep growing our forest and then live off the seeds that it produces. This means our investment strategy is much less stressful, especially as everything is set up to automatically reinvest our dividends each time we receive them.
It takes time for your investments to grow and dividends to feel like they are significant. Just like it takes time to grow a real forest. This is why I want to encourage all parents to start investing for their children. The sooner they start, the more time for their forest to grow and start to produce more seeds.
If you are uncertain about how to invest for yourself and your kids, please check out my FREE investment guide here.
Investing in the stock market has been the topic that those who have watched my online course have really enjoyed. You can check it out here.
Thanks for reading!
Useful links to other blogs mentioned above:
P.S. If you want your kids to learn more about investing, then make sure you get them a copy of Grandpa’s Fortune Fables.