Welcome to Part 2!
“Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas.” – Paul Samuelson
When most people think about investing, they conjure up the image of a day trader, hedge funds and options traders glued to their monitors filled with complex graphs or the raucous New York Stock Exchange trading floor.
Buy low, sell high. Someone wins, someone loses. Big wins, but also so many, many thunderous losses.
This is also no different than going to the casino and gambling. I’d rather keep my money, thanks!
However, what if I told you – you never have to sell your shares in order to make money? It’s true.
But first, in this post let’s go over the basics. I’ll touch on 3 topics:
- The importance of time
- The power of compounding interest
“You get recessions, you have stock market declines. If you don’t understand that’s going to happen, then you’re not ready, you won’t do well in the markets.” – Peter Lynch
Recessions happen. However, when you invest for dividends you are in it for the long run. Just like the four seasons, after winter spring is just around the corner. the economic cycle starts all over again and markets recover. Just be sure you are still around for when things go back up and you don’t leave when a downturn occurs.
I am not a fortune teller. I can’t tell you when the next recession will happen. The last one was in 2008, 10 years ago. So no matter what, there will be another recession. A mini one or a big one, I don’t know, but it will happen.
Remember, it is not the timing of the market that is important, but the time spent in the market. This will all make sense when we take a look at compounding interest and dollar-cost-averaging next.
The Power of Compounding Interest
What is compounding interest? Sweet and simple, it’s literally interest on the interest. Once your money earns interest and is reinvested, that interest earns interest etc. Compounding on itself – thus compounding interest.
Why is it important? Your money grows faster and faster over time. The more time you allow your interest to compound the quicker you accumulate more money.
Check out this cool illustration over at Direct Investing. They even have a nifty calculator to see how much you can earn over time.
Now, onto dollar-cost-averaging…
Yep, more math. But I promise, it is not hard!
All dollar-cost-averaging is, is putting in small amounts of money on a consistent basis (like once a month or once a quarter).
By buying shares in a company slowly, you are in turn buying the stock at different price points. Sometimes high, sometimes low.
Here is a nice example.
If you are putting in the same amount each time, lets say for simplicity sake $100 per month, and the price this month is $50 per share. You will end up buying 2 shares. Next month the price drops to $25, with the same $100, you buy 4 shares. Then the price jumps to $80 by the third month, you only buy 1.25 shares.
After 3 months you would have 7.25 shares and spent $300 total, at an average price of $41.38 per share. If you bought $300 worth at $50 the first month, you would only own 6 shares. At $80 per share, you would own just 3.75 shares! Dollar-cost-averaging can help you buy more shares, which will earn you more dividends in the long run.
If the price is high, you buy less. When the price of the share is low, you buy more. Over time the price at which you purchased your shares averages out to be a bit lower.
Neat, eh? Besides, I really love it when the things are on sale 😉
AND… the cool thing is, if you reinvest your dividends automatically you are already putting dollar-cost-averaging and compounding interest to work! Easy-peasy.
That’s it for this post!
Join me next week for Part 3, where I get into the nuts and bolts of how to buy your first share.