Einstein once remarked that “Compound interest is the eighth wonder of the world. He who understands it earns it… He who doesn’t…pays it.” Compound interest – interest earned on interest – is a driving force to building wealth.

In William Green’s book Richer, Wiser, Happier he demonstrates the (nearly incomprehensible) effect of compounding, with a legend of an Indian man who supposedly invented chess. He presented his game to the king, who offered him a reward. The game inventor requested one grain of rice for the first square of his chess board, two grains for the second square, four for the third square, and so on, all the way to the sixty-fourth square. The king quickly granted the request- thinking it a meager prize for a fantastic invention. However, the king was alarmed when his treasurer informed him that this decision left the kingdom bankrupt. Without realizing it, the king owed the game inventor 18,446,744,073,709,551,615 (18+ quintillion) grains of rice.

Image Source: The Motley Fool
Compounding wealth is the benefit to long term investing; like the supposed inventor of chess you want to take advantage of this wonder. Of course, if you invest $1, your goal is to prudently double that $1 as often as possible. For example, with an annualized return of 7% (historically lower than the long-term return on US large cap equities), your $1 investment would double every ~10 years. The longer the runway, the greater this compounding effect will be.

We are biased towards dividend growth stocks since they magnify the power of compounding. These quality businesses consistently pay, and grow their dividends over time. Additionally, the cash received from the dividends can be reinvested into the portfolio to build its value.

"The best time to plant a tree was 20 years ago. The second-best time is now" - Chinese Proverb

Quick Hits

Helpful comments from our Global Insight Monthly, provided by RBC’s Global Portfolio Advisory Committee. Let me know if you’d like a full copy of the report.

• Given stocks’ short-term volatility, I marvel at the consistency in the rolling 30-year returns in the S&P 500 (an index of the 500 largest American companies). The below chart shows the rolling 30-year returns (the blue line, since 1950) compared with the latest 1-year returns (the orange bars, since 1980). Stocks are a great long-term investment despite (and oddly, because of) their volatility.

Source: A Wealth of Common Sense

• Fitch, a ratings agency, downgraded the US government’s credit rating from AAA to AA+. This decision was spurred by weaknesses in the US budget process and outcomes. Our Portfolio Advisory Group thinks that the loss of AAA status is unlikely to have a significant impact on US Treasuries, since the issues raised are well known and unlikely to be material in the near term. Similarly, Warren Buffett is not worried about this downgrade. On the other hand, Johnson & Johnson and Microsoft- 2 companies we own in many portfolios- are rated AAA.
• TC Energy (TRP) has been a laggard for us lately. The company has been dealing with a few recent headwinds (cost overruns on their Coastal GasLink project, lower-than-expected multiple on the sale of their Columbia assets, above average leverage, confusion about their proposed spin-off). The market may keep TC Energy in the “penalty box” until there is further clarity and progress around these issues. In the meantime, TC Energy pays an attractive dividend that RBC thinks is sustainable. Coupled with an attractive valuation, we continue to like this stock- a conviction supported by meaningful insider buying last week.

• Broadly speaking, Canadian stocks are attractively priced as they’re trading one standard deviation below their long-term Forward P/E ratio. By comparison, US stocks are trading one standard deviation above their long-term Forward P/E ratio.

Please feel free to reach out if you have any questions. Have a great month!

This information is not investment advice and should be used only in conjunction with a discussion with your RBC Dominion Securities Inc. Investment Advisor. This will ensure that your own circumstances have been considered properly and that action is taken on the latest available information. The strategies and advice in this report are provided for general guidance. Readers should consult their own Investment Advisor when planning to implement a strategy. Interest rates, market conditions, special offers, tax rulings, and other investment factors are subject to change. The information contained herein has been obtained from sources believed to be reliable at the time obtained but neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers can guarantee its accuracy or completeness. This report is not and under no circumstances is to be construed as an offer to sell or the solicitation of an offer to buy any securities. This report is furnished on the basis and understanding that neither RBC Dominion Securities Inc. nor its employees, agents, or information suppliers is to be under any responsibility or liability whatsoever in respect thereof. The inventories of RBC Dominion Securities Inc. may from time to time include securities mentioned herein. RBC Dominion Securities Inc.* and Royal Bank of Canada are separate corporate entities which are affiliated. *Member-Canadian Investor Protection Fund. RBC Dominion Securities Inc. is a member company of RBC Wealth Management, a business segment of Royal Bank of Canada. ® / TM Trademark(s) of Royal Bank of Canada. Used under license. © 2020 RBC Dominion Securities Inc. All rights reserved