Dividend/Compound Interest Question

[thefrugaltwo]

Hello Again,

Here's my beginner investing question of the week (thanks art school!). So I saved the money, I know which fund I'm going to start with. So here's what I think I know about dividend's/compound interest, please tell me if I'm understanding this correctly:

1. When you have a fund, the interest gained each year are called dividends.
2. If you roll those dividends back into that same fund you are basically having the money work for you again and earn interest again, and that's called compound interest.

Do I have this right? I know I may be oversimplifying a bit, but is this basically the right idea?

Random other dividend question: How can I make sure this happens? For example, if I open an index fund (I think I'm going with VTSMX from vanguard), will they automatically roll that over for me, or will I have to do something to make this compound interest happen? Like, I don't know, fill out a form or specify that I want the dividends to go right back into the fund?

Sorry if this is a very basic question, I'm just trying to figure out what to expect.

[Nothlit]

That is basically correct, yes. Compound interest results from prior interest being accumulated into the total balance and continuing to earn new interest. I believe Vanguard asks during the account setup process whether you would like dividends and capital gains to be automatically reinvested or not. In any case, it is easy to change your selection via the web site at any time. And you could always manually reinvest dividends as well, but having it be automatic means you won't forget or be tempted to use the money for some other purpose.

[thefrugaltwo]

Thanks very much, that's all I wanted to know. Here I go, off to open my first fund! :)

[DoubleDown]

For clarification, you can make money in your investments in two basic ways (ignoring all the more exotic ways of investing in stocks and funds):

1) The price of the investment goes up over time, so when you sell your investment, you capture the gains at that time. If you buy 1 share of McDonald's at $10/share, then it goes up to $12/share, you will make $2 profit when you sell.

2) The investment pays dividends periodically, which you can either take out or have reinvested. This is really just (1) above, but in this case, the company or investment broker has decided when to sell some portion of the shares or profits to give back to you. So when McDonald's goes to $12/share, they might pay out $1/share in dividends, and the stock will drop to $11/share. This is of course a greatly simplified example.