How to Become a Retirement Millionaire

True or false: Investors coined the term "New Economy" during the 1990s technology boom.

False.

Fortune celebrated its 25th anniversary in 1955. To mark the occasion, the magazine ran a special series devoted to "The New Economy." It praised American innovation and rejoiced in the massive wealth accumulated by Americans since the Great Depression.

Most people have forgotten it, but the 1950s was a decade of incredible technological advancement. Take the television, for example. The speed of TV's market penetration far exceeded that of the PC or the Internet. In 1948, total sales had reached 148,000. By 1952, Americans owned 50 million television sets.

By 1950, American firms had switched from producing munitions to consumer products, and they were using technology to push their profits. Papermate developed the first mass-produced leak-proof ballpoint pen, and Haloid (later named Xerox) developed the first copy machine. Diner's Club introduced the first credit card in 1950, and Bell Telephone Labs had just perfected the transistor.

I'm reading Jeremy Siegel's book The Future For Investors at the moment. After using these facts to show how 1950 marked the real beginning of America's technological revolution, Siegel poses the reader this challenge:

You travel back in time to 1950. You may purchase the stock of an industrial company or a technology company. He uses Standard Oil of New Jersey to represent heavy industry, and IBM to represent the technology. Once you've made your decision, you must lock your stock away for 50 years.

To help your decision, Siegel provides some common measures of performance for IBM and Standard Oil for the period 1950-2003:

The challenge: Which company would you choose for the greatest investment return: Standard Oil or IBM?

Before I tell you the answer, let me explain Siegel's "Growth Trap."

Most investors think the best way to get rich in the stock market is by buying groundbreaking firms – the ones on the cutting edge of new technology and innovation. But Jeremy Siegel's research shows this is a clever stock market trap... and the exact opposite is true:

"Not only do new firms and new industries fail to deliver good returns for investors," Siegel writes, "but their returns are often inferior to those of companies established decades earlier."

Why? Market expectations hold the answer. Growth stocks are already expected to grow. So you'll only make money in them if they grow beyond the markets high expectations. Old economy stocks are not expected to grow. So even if they only grow slowly, you'll still make money.

As a result, entrepreneurs, founders, venture capitalists, and investment bankers make fortunes from new industries. Individual investors make money through value investing. And you find value in the old established stocks... like Standard Oil of New Jersey.

Here's a how annual investment return in IBM and Standard Oil compared between 1950 and 2003:

Although the difference in annual returns is only half a percentage point, when you opened your lock-box 53 years later, $1,000 in IBM stock would have grown to $961,000... but $1,000 in Standard Oil would now be $1.26 million... a difference of 24%.

Notice how the dividend yield made the difference in this experiment. IBM's share price performed better, but Standard Oil's high dividend yield made the difference.

"A very important reason that valuation matters so much is the reinvestment of dividends," concludes Siegel. "Dividends are a critical factor driving investor returns. Because Standard Oil's price was low and its dividend yield much higher, those who bought its stock and reinvested the oil company's dividends accumulated almost 15-times the number of shares they started out with, while investors in IBM who reinvested their dividend accumulated only three-times their original shares."

In sum, for individual investors, valuation is the most important consideration when choosing stocks... especially the price you pay for dividends. If you're a long-term investor looking to build a huge retirement, Siegel recommends you favor established companies with high dividend yields over high-growth companies with low dividend yields.

Good investing,

Tom