From Mark Ford, editor, Creating Wealth: Yesterday, I told you about a special service we’ve set up: the Legacy Portfolio. If you missed it, you should read about this service here.

I explained how the Legacy Portfolio would differ from our other PBRG services, The Palm Beach Letter and Mega Trends Investing.

The Legacy Portfolio is designed to give you maximum long-term growth. It requires little maintenance (no stop losses). It is virtually impervious to market fluctuations. And most importantly, it is the simplest and most efficient way to grow enormous wealth.

I told you how it works, but I didn’t fully explain the central component of the strategy: the miracle of compounding.

So today, I want to elaborate on compounding to make sure you understand why it is so important—why it’s such a powerful wealth builder—and how the Legacy Portfolio takes advantage of compounding.

The Power of Compounding

Of all of the many investment strategies that exist, why did Albert Einstein call compounding “the eighth wonder of the world”?

It’s because nothing else has the power to create great wealth so surely.  

Compounding works like this: You put your money in an investment that pays a return. At the end of the year, you take that return and reinvest it with your original stake. Your dividend (or interest) earns a return too. This gives you a bigger, compound return in the next year.

Compounding is slow and boring at first, but as time passes, the dividends get exponentially larger. Eventually, you wake up to discover that you are making huge dividends every year, while your account grows to an enormous size.

A snowball is the best analogy for compounding. As you roll the ball through the snow, the surface area gets bigger. The more surface area on the snowball, the more snow it picks up. The snowball gains mass slowly at first… but pretty soon, it’s so large you can’t move it.

Here’s an example. An 18-year-old girl puts $2,000 into an account each year for seven years. Then she stops. She never puts another nickel in the account. Her $14,000 sits there earning interest at a rate of 10% each year.

How much will the account be worth when she is ready to retire at 65?

The answer is $944,641—almost a million dollars. She will have become a wealthy woman at retirement simply because she invested a modest amount of money and allowed it to compound over time.

Not only is compounding the best way to build long-term wealth, but it is also the easiest. You can take full advantage of this strategy without watching the markets every day or setting stop losses or hedging your bets. The only thing that you must do is decide what kind of investment or asset class compounds the best.

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The Best-Performing Asset of All Time

The answer to that question is easy. Compounding works best with stocks.

Jeremy Siegel is a professor of finance at the Wharton School of the prestigious University of Pennsylvania. He studied the returns of different types of asset classes like cash, gold, Treasury bills, bonds, and stocks over a 210-year time frame.

The results were astonishing.

From 1802 to 2012:

 

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$1 kept in cash would be worth 5 cents in 2012.

 

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$1 invested in gold would be worth $4.52 in 2012.

 

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$1 invested in Treasury bills would be worth $281 in 2012.

 

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$1 invested in bonds would be worth $1,778 in 2012.

 

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$1 invested in stocks would be worth $704,997 in 2012.

 

Those are the actual numbers: Yes, cash fell to 5 cents and stocks grew to an astonishing $704,997!

Gold and bonds have an important place in your wealth-building strategy, but when it comes to Legacy Investing—i.e., building long-term wealth—stocks are the only way to go.

You may be thinking, “Two hundred years is a long time. After all, the average life expectancy of a U.S. male is 83 years.”  

So how would stocks do over a shorter period of time—say, 54 years?  

In The Future for Investors, Siegel answered that question. Between 1950 and 2003, a $3,000 investment in the S&P 500 would have given you a return of $1,323,936. That’s very impressive.

But had you invested that same $3,000 into three companies that have enduring, competitive advantages, your total return would have been $5,080,054 using the same time frame!

Here are the stock-by-stock results. One thousand dollars invested turned into a:

 

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Balance of $2,042,605 in Kraft Foods

 

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Balance of $1,774,384 in R.J. Reynolds Tobacco

 

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Balance of $1,263,065 in ExxonMobil.

 

Why did these three stocks outperform a broad stock market index fund by four times?

It’s very simple. They all focused on basic human desires and necessities. Things such as food, cigarettes, and fuel. And they all had what Warren Buffett calls enduring competitive advantages.

Siegel’s work confirms what I’ve been saying: To build serious, long-term wealth, you need—in addition to strategies that bring you shorter-term income and growth—a long-term strategy that takes full advantage of compounding.

 Siegel’s work also confirms the importance of selecting the right stocks.

Thus… Our Legacy Portfolio

This brings me back to the Legacy Portfolio, the stock portfolio we created to take advantage of the laws of compounding to create long-term wealth.  

Tom has established eight criteria to determine whether a company is worthy of being included in the Legacy Portfolio. (I hinted at these in my essay yesterday.) You can generate enormous amounts of wealth by finding companies that meet these criteria.

Reeves’ Note: Today, we’re “unlocking” the second installment of a training event Mark and his Legacy team are providing. It’s a free educational series on how to harness the power of Legacy investing. It’s called…

Then, on Thursday, April 23, at 8 p.m. EST, you can join Mark and Tom for a free, live Legacy workshop and Q&A session. If you’re excited by the prospect of using Legacy investing as the safest way to build stock market wealth, click here to access the training.