Author Topic: How do I take advantage of compounding when investing in stocks?  (Read 1456 times)

Dora the Homebody

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I'm new to the investing game and I'm not quite understanding how investing in equities/index funds makes money.

The more I read about how important it is to take advantage of compounding interest, the more confused I am.

My current understanding is that you buy stocks, they go up in value, and then you sell = profit.

But I can't reconcile this with "buy and hold"?

I currently have an RRSP & TFSA and I'm paying huge MERs; now that I'm getting educated I see that needs to change ASAP.  Looking into index funds/ETFs, but don't want to make any big changes until I have a better understanding.

If anyone can help clarify I would appreciate it.


FIREby35

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #1 on: March 18, 2017, 08:12:05 AM »
Please read this book:

The Simple Path to Wealth, Jim Collins

L.A.S.

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #2 on: March 18, 2017, 08:12:37 AM »
Annually companies produce earnings.  A portion of earnings is returned to shareholders as dividends. A portion is retained earnings kept by the company and is invested to grow the business with an eye towards increasing future earnings.  The business decision to retain earnings and invest in the company causes a compounding effect.  And as a shareholder, if you reinvest your dividends this will result in additional compounding.

Heckler

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Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #4 on: March 18, 2017, 08:32:16 AM »
Then here, but change US references to Canada. 401k=RRSP; Roth/IRA =TFSA for example

https://www.bogleheads.org/wiki/Getting_started
« Last Edit: March 18, 2017, 08:35:10 AM by Heckler »

Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #5 on: March 18, 2017, 08:33:19 AM »
Then here for reference.

http://www.finiki.org/wiki/Main_Page

Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #6 on: March 18, 2017, 08:37:17 AM »
I think the video in Bogleheads #6 answers your specific question.

https://www.bogleheads.org/wiki/Video:Bogleheads_investment_philosophy#Use_index_funds_when_possible_.28Rule_.236.29

Dora the Homebody

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #7 on: March 18, 2017, 08:40:26 AM »
Thank you for the replies.  I have been reading CCP.  I'm thinking about starting out with Tangerine until I am comfortable with self-directed investing.  Do all index funds pay dividends or do I specifically need to seek out index funds that do?

Dora the Homebody

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #8 on: March 18, 2017, 08:42:18 AM »
thank you for the bogle link.  That particular video didn't show up but I am going to peruse the info there.

Nothlit

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #9 on: March 18, 2017, 08:45:48 AM »
Thank you for the replies.  I have been reading CCP.  I'm thinking about starting out with Tangerine until I am comfortable with self-directed investing.  Do all index funds pay dividends or do I specifically need to seek out index funds that do?

Dividends are not necessary for compounding

Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #10 on: March 18, 2017, 08:46:01 AM »
The bogle links tend to not work as links because of the stupid (R) in the link. Copy and paste the whole link instead of clicking.

Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #11 on: March 18, 2017, 08:52:33 AM »
Moneygeek may also be the simple explanation you are looking for.  He has a great set of introduction videos

https://m.youtube.com/watch?v=xMkzF3bawvY

Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #12 on: March 18, 2017, 08:59:32 AM »
In fact moneygeeks video 1 is exactly what you are asking.  Couple it with Bogleheads Rule 6, and i think you have your answer.




(Rule 6 video direct link)
« Last Edit: March 18, 2017, 09:02:45 AM by Heckler »

Roland of Gilead

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #13 on: March 18, 2017, 09:07:34 AM »
Ever had a dollar sitting in your mattress get friendly with another dollar and make a baby?

Stocks can do that.  Either through dividends, buybacks (which reduce the shares outstanding and make your shares more valuable), or just an increase in value in the shares.

While stock splits don't directly add value immediately they should be accounted for when looking at certain stock prices.

Apple was around $14 a share in the early 1990s so say you bought 1 share.   It split 2 for 1 in 1997, so now you have 2 shares.  It split again in 2000 so you have 4 shares, in 2005 another split, so 8 shares.  Finally in 2014 it split 7 for 1 so now you have 56 shares which today are worth $7840.  You also got paid some dividends in there but we will ignore that for simplicity.

So your total return was 5700% over a roughly 25 year holding period.   This is roughly equal to money earning 29% interest compounded yearly for 25 years.   A saving account with a 29% interest rate.

TheAnonOne

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #14 on: March 18, 2017, 09:19:44 AM »
Thank you for the replies.  I have been reading CCP.  I'm thinking about starting out with Tangerine until I am comfortable with self-directed investing.  Do all index funds pay dividends or do I specifically need to seek out index funds that do?

Dividends are not necessary for compounding
Though, most index funds own companies that do pay some.

For instance, the big one here, VTSAX contains about 3500 companies (every publicly traded company in the USA)

Some of those do pay dividends and the net effect is about 2% a year "extra"

Sent from my SM-G935T using Tapatalk


Heckler

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #15 on: March 18, 2017, 09:20:43 AM »
But if you bought Tandy instead of Apple, your compounding was negative and you live in a cardboard box now. 😉

If you bought both of them, (and all other companies in the index), your return is an average of the two.

Dora the Homebody

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #16 on: March 18, 2017, 09:49:39 AM »
Thank you again.  I have a lot to learn and I'm sure I will have more questions as I go along.


frugledoc

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #17 on: March 19, 2017, 03:48:19 AM »
Dividends / buybacks / gains all compounding.  Once the train gets rolling it's an amazing thing to see

marty998

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #18 on: March 19, 2017, 04:15:33 AM »
Step 1: Buy index fund,
Step 2: Put in bottom draw
Step 3: Wait 45 years
Step 4: Open bottom draw

I think Futurama explains it best when Fry goes to the bank for the first time in a thousand years and gets told he's a trillionaire.

MustacheAndaHalf

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #19 on: March 19, 2017, 04:31:16 AM »
I think you're asking the wrong question, from an earlier era.  Yes, "the power of compounding interest" is a great idea.  With bonds and CDs, it still works that way.  And it worked that way decades ago.  But in more recent years, companies have realized they can make better use of money than by issuing dividends.  Plus dividends require investors pay taxes, while simply growing the stock price can delay taxes.  If you only bought dividend producing companies, you would miss out on some very significant growth in the market.

In general, it doesn't matter if a stock goes up 7% (no dividend) or 5% + 2% dividend.  Most stocks are roughly growing at a similar rate, and you can capture that growth with an index fund.  Instead of worrying about dividends, worry about stock growth and annual expense ratios.

"A Random Walk Down Wall Street" is probably too much to ask given the number of books and reading you've already been given.  There's a very short book "The Investment Answer" that comes in under 100 pages and is probably more appropriate given the long list of reading suggestions in this thread.  Just make sure you get advice from authors that use decades of stock market history, and who like to occasionally mention academic research.

I'd actually say awareness of expense ratios is more important than knowing about dividends.  I'd suggest you learn more about annual expense ratios, and worry less about how the growth happens in a broad index of stocks.

Dora the Homebody

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Re: How do I take advantage of compounding when investing in stocks?
« Reply #20 on: March 19, 2017, 06:48:53 AM »
I am making notes of all these books.  I've recently completed my first book, literally "Investing for Canadians for Dummies".  Next on the list is "The Millionaire Next Door" which was recommended from the If You Can by William Bernstein... I think I got the link for that pdf somewhere on here.