When the dividends start, they aren’t very big and don’t come in very quickly. For the first few years of investing most people don’t even notice the payments - though they might notice the hole in their chequing account that is their small purchase of shares.
Today’s post is dedicated to explaining two tools that put those tiny payments to good use and get everyone closer, faster, to their financial goals.
Let’s revisit the principle of compounding interest. Imagine a product that returned 10% yearly interest (easy to do math with, but not so easy to find). You as the investor have two and only two options for what to do with that interest money. You can either remove it from the account OR you can return it to the account and have it continue to accrue more interest.
Let’s examine both graphically with an initial investment of $1,000 over 20 years.
$2,000 isn’t too bad for doing no work of course, but let's see if we can do a little better.
There is another story where we choose to take the returns we get every year and just keep them in the account, still doing no work mind you, just leaving everything alone.
As you can see, in this scenario the next year’s growth is calculated based on the value of the previous year. In year 2, the value would be $1,100 - same as Scenario 1. Year 3 however would be calculated as 10% on top of $1,100 instead of $1,000 - or $1210 ($10 additional dollars for free). This put’s you significantly ahead over time relative to where you would have been had you simply spent the money.
How to Make This Work for Your Stock Portfolio
Your broker (thing that you use to buy/sell stocks) needs several things. First, the ability to buy something called Fractional Shares. Second it needs a DRIP Program. DRIP stands for Dividend Reinvestment Plan.
The way it works is that every time a dividend is paid out (once every 4 months for stocks and ETFs, sometimes once a month for certain mutual funds) the broker takes take money directly and buys a fractional share. This is simple a portion of a share that you buy for less than full value. For a $100 stock, if you receive $10 in dividends the broker will buy 0.1 shares and add it to your position. The best part is you get all the dividends for those fractional shares. Owning 10% of a share gets you 10% of the dividends, provided they amount to more than $0.01 which may not be the case if your position is too small.
This allows your portfolio and your dividends to grow automatically over and above your regular contributions.
If you are the type of person who never wants to deal with this stuff ever (which is a very good thing to do if you set yourself up right) most brokers have a recurring investment option. That allows you to drop as much money as you like into your investment account and the broker will do the buying for you as often as you select, up to and including daily investments. You can start with only $1 per day.
How Often Should I Set My Recurring Investments?
Daily.
Why? It makes more sense to invest less money more often than more money less often. The value of your holdings will go up and down daily. Sometimes as much as 8+% but usually more like 1-3%. All this will happen while the overall weekly change in the price might be no more than 1%.
Investing $1 a day in a stock that declines randomly 2% 2/7 days in one week and has the price recover to parity on Friday means that you have earned at least $0.04 more than you would have than had you invested $7 all on the same trading day.
Final Thoughts.
Investing can be extremely complicated, and lot’s of people make fortunes through those complications. The thing is though, most do not. Over time, the people who make the most money in the market are those who throw their hands up and say they’d rather do something else.
It’s very profitable to have an investment advisor look at your holdings about once a year, just to make sure you’re on the right track. But otherwise, the most profitable course is just to drop money into your account and let a broker make automatic buys with it and your dividends.
That’s it for this week everyone!
Sincerely,
James R. Davies.