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This is part 4 of the 5 episode “Back to the Basics” series from The Investing for Beginners Podcast. Each episode covers the fundamentals of the stock market and investing to provide a solid foundation for those who are looking to compound their wealth over time.
Here are the links to each of the episodes:
Back to the Basics Pt 1: The Anatomy of Stocks and Shares
–Defining what a stock is
–Talk about the big 3: the cash flow statement, balance sheet, and income statement
Back to the Basics Pt 2: Share Dilution on Wall Street
–What is a stock
–What are stock buybacks and how they affect us
–What are share dilutions
–What happens when we buy or sell a stock
Back to the Basics Pt 3: Stocks vs Other Investments
–Peer to peer lending
–Gold and other precious metals
–Bitcoin and other cryptocurrencies
Back to the Basics Pt 4: Investing 101 and Compound Interest
–The importance of buy and hold
–Compound interest and how it can make you wealthy
–Using a compound interest calculator
–The power of dollar cost averaging
Back to the Basics Pt 5: Dividend Stocks and Value Investing
–The advantages of buying low and selling high
–Dividends and the power of compounding
Welcome to Investing for Beginners podcast this is episode 46. Andrew and I are going to continue our series on back to the basics, and today we’re going to talk about buy and hold and why that’s important. As well as compound interest and some other interesting topics. So without any further ado, I’m going to turn it over to Andrew, and he’s going to start off our chat.
- The importance of buy and hold
- Compound interest and how it can make you wealthy
- Using a compound interest calculator
- The power of dollar cost averaging
Andrew: If you’ve read any investing books and gotten involved with the whole scene, these are a lot of the things that are similar themes. I’m hoping with these episodes that we’re going at such an in-depth level that you’re still picking up things that are valuable.
The whole goal of this is to get things to stick. Because it’s one thing to hear something but if you can take these basics and master them– give yourself the reasons why and give yourself not just the how but the why. Give yourself a firm foundation and understanding on why these things are applicable and why, when things get tough, you’re going to have these values to stick to. It’s important to get this mastery rather than just floating through the wind, and when adversity comes, if you don’t have this foundation you might forget about all these lessons or you just might be stubborn and not listen to what’s been proven.
And this kind of like conventional logic when it comes to the stock market and investing and so I think it really can have a big impact on your final results as you navigate through the stock market.
I think that applies whether you’re an absolute beginner or even if you are more seasoned. Getting these lessons drilled and mastered can go a long way. I would recommend going through them I think there’s a lot of good value here and obviously, today even if you’ve heard that you should buy and hold or you should diversify or you should dollar cost average.
The kind of things that you always hear I think it’s still important to get some more information and get some more. because you know these are the kind of things that I would want to teach to somebody who’s close to me if they’re getting first started in the market and try to get a broad sense of everything you need to learn and also really laser focus down into the big fundamental principles and why they’re they are.
I think it can be useful in that way too what I did and why I want to talk about buy and hold first is this is something you’ll hear a lot, and this is something that really will be your biggest advantage in the stock.
When you’re buying stocks is this idea of buy and hold, so what buy and hold means is buying a stock and holding it. It’s not trying to time the market; it’s not trying to buy a stock low and sell high and kind of being done with it. I mean buy low sell high is very important but at the end of the day, you’re going to win not because of the stocks that you pick and the individual companies. You’re going to win because you are in for the long term.
I’m sure you’ve heard over and over and over again about the metaphor with the tortoise and the hare and how it’s important to be patient and to look at everything in the long term, and that’s not for the wrong reasons. Just because it’s conventional wisdom when it comes to a lot of different areas in life, it’s because this is going to be a big advantage to investing in the stock market and especially in the stock market and especially in the environment that we are in today.
This environment that we’ve seen for years and decades past and it’s really valuable to understand these things so when we talk about buying what that means is investing is not like a single action or choice.
Investing is going to be something that’s the long term that you’re consistently making a habit and that when you reach financial freedom, the idea is that you’ll still be invested. But you’ll be able to draw from your nest egg, as a lot of the personal finance people like to call it, the nest egg.
Being able to draw from that and also keeping it intact so it allows it to grow and so you have like a golden goose to say. So you have these goose that’s laying golden eggs, but you’re not killing the goose the goose is still laying eggs, and it continues to grow over time.
Assuming that you’re in there for the long term, assuming that business continues to run, a business does for the next decades and years to go ahead.
One way that I think to buy and hold is powerful and other than just hearing it from people over and over again is I took some simple facts right. Look at the S&P 500, which is the index that we look at when we talk about the stock market; it’s a representative of a good majority of the stocks that are in the US, and it’s been the driving factor.
There are tens of trillions of dollars currently in the S&P 500 and it just makes a big portion of not just the US economy but the world economy as a whole. These are major corporations that are driving business in the entire world and so what I did was I looked at a stock chart of the S&P 500 and we can get some great lessons from this just looking back into history. As an aside you know you used to be able to do this with Google Finance for whatever reason they took out that that feature so I used Yahoo Finance and it showed me S&P 500 data all the way back to 1970.
What I found interesting when looking at this data was that obviously you look at a long-term chart of the S&P 500 and especially at a time like today. After a very long bull market we’ve seen this sort of prosperity and all these great gains that have come from the market recently because of the strong economy and a lot of people putting money into stocks.
You see a general, and it looks exponential now because of how much growth we’ve seen the past couple of years you go from the bottom left of a screen to the top right on the screen you see a nice a nice growth, and depending on which period you look at it’s going to be something similar when you look at a long enough time frame.
What I found interesting is that obviously it’s gone from lower to higher levels and it’s seemed to consistently get higher, so even though you have recessions; even though you have bear markets, even though you have stock market crashes… you know it has always recovered and it’s done that not only since the 1970s, which is when this data is out, it’s done that for hundreds of years and it always recovers at a higher level than them.
Where it was previously, so you’ll see for example in 2000, and then you had the crash after the dot-com bubble, the markets definitely recovered from that and then continued to go higher. That’s why you always hear all-time highs, it’s important to look at the data and still get some perspective on that.
What I did was I looked at 20-year time periods so when you’re talking about investing you want to be a long-term investor and usually you know from a technical standpoint they’re talking about holding an investment for longer than a year. That’s when the capital gains specifically determines your investment as a long-term investment rather than a short-term investment. That’s just a technical term, but really if you’re gonna get into the stock market and you’re expecting to have consistent and reliable gains from the stock market.
You really should be looking at a period of not even 10 years, but 15 to 20 years and I think this data should really show you why and that’s a big reason why when you talk to financial advisors they have like target funds and they’ll they’ll tend to change your allocations between stocks and bonds depending on how close you are to retirement so we talked about bonds last week and you know some of the impacts of it how has a lot lower volatility than stocks. how it can really preserve your capital especially in a shorter time period because of the nature of bonds and so you know when you have a 55 year old investor who has only 10 years to retirement probably it a lot of financial advisors will recommend getting more into bonds than stocks at that time and it’s because that these financial advisors understand how the market has historically worked. and understand how just investing works in general and how the S&P; 500 it has acted.
Somebody with who’s 55 will have a different asset allocation is the technical term behind it they’ll have a different asset allocation and different exposure to the stock market then like a 35 year old or a 25 year old somebody with the ability to be able to stay in the market for 15 to 22 to even longer time periods. so what I found was interesting is I took just random 20-year time periods right obviously you have bull markets you have peaks and Trump and peaks and troughs and you have times where the market has lost a considerable amount of money.
Even from I think the let me see I have on my website this was recent as of 2013 the most the sp500 ever lost in the year is 38.4 t 9%. so I mean you know when you compound that over a couple years. yeah a lot of people lost half of their money for a whole year you’re talking about less than half and you’re talking about recoveries within the next couple years after that.
While you know things really gets essentialized and people really freak out and think the world is ending when these type of things happen it’s been proven time and time again and it has not failed yet that the market always recovers that’s not as we’re recording this today in 2017 that’s never not happened. there’s always been a recovery and yes there has been short-term hard time periods but there’s always been recovery over the long term we’ve always seen capital growth in the S&P; 500 the worst one-day loss for the S&P; 500 was in 2008 and there was a minus 9 percent.
Again I mean you know these are significant numbers but we’re not talking about amounts that should really draw anyone to suicide they’re draw and you want to really have significant damage to themselves as long as they keep to principles as long as they stay like everything we’re talking about in this episode today. as long as they buy and hold and they and they hold for the long term and they diversify in the dollar cost average all those things.
Obviously, there’s extremes but this is why the principles matter and this is why this is how you can utilize them and really keep yourself away from the highly charged emotions that tend to happen when we have trouble.
So 1970 to 1990 let’s take a 20 year time period and obviously with every 20 year time period there were peaks and valleys and ups and downs and crashes and consistent gains. but 2004 20 years I’m always seeing significant gains from 1970 the SP was around 100 1990 it was almost 400. so we’re talking about a 4x okay 1980 to 2000 went from around 132 to around 1400 that’s huge 1990 to 2010 from 320 ish to a thousand so you know from 2000 to 2010 you actually saw it decline. but still over a 20 year time period we’re seeing huge gains from 1997 to 2007 1987 was around the time right before the big dot-com bubble.
It was actually still kind of brewing if you will we’re talking about from 17th from 786 to 2673 that’s over triple okay a common theme here it’s over 20 year time period we’re seeing doubles triples quadruples and so okay you might be thinking well that sounds really cherry-picked right.
We’re just going 1970 1980 1990 maybe it just so happened that those 20 year time periods were good ones to pick so what I did was I went to the absolute bottoms of the markets right and let’s look at the 20 years prior to that and compare it to now so 2002 was a market bottomed the S&P; was at 8:15 rewind 20 years in 1982 the S&P; was around 116 so a lot more than quadruple there 2009 was another market down looking at around 800 20 years prior 1989 it’s around 300 so you still doubled your money and this is doing the absolute worst timing and looking over just a 20 year time period you can obviously hold longer and maybe see better gains let’s look at another one 1987 around 1987 we saw I think it was Black Monday and some other traumatic events in the stock market talking about the SP around 250. now the data doesn’t go back to 1967 which would be 20 years but 17 years prior 1970 just how far back it goes you’re looking at the S&P; around 90 to 100 so still up.
Your money’s still about doubled even though we are doing the hypothetical of selling at the market bottom we covered this a lot in episode 2 we had a guest on named Braden he’s a listener and on the tangent he actually has a cool podcast now called The Canadian Investor. so he’s somebody who is an absolute beginner and now has been able to take some of the knowledge that we’ve taught through the podcasts and our other resources and now he’s really venturing on and getting more skills with the stock market.
I think that’s really cool but we talked about on that episode episode 2 how timing the market doesn’t matter that much. there was an investor who always invested at the wrong times 1973 1987 Black Monday 1987 2007 and he put 50,000 in the market at each of those times which were right before you know the market pretty much tanked each time and he still made over 1.6 million just because he held and continued to let the money grow and let the market do its thing over time.
One last thing on the on the chart with the S&P; 500 we I talked about 20 year time periods I think that’s now that I just kind of looked at the data I think that’s a really nice place to be in and when we talk about long-term investing no one really has a definition but I think that’s a great place to start and you should have a lot of confidence in knowing that because this is what the market has done for pretty much every 20 year time pair you can look at this is why we’re gonna be confident this is why we’re gonna hold and this is why when the media says the world is ending and the economy’s in the gutter and there seems to be no way out this is why we’re gonna still hold and we’re gonna let the market recover and not worry that well I might have bought at the top or you know the markets been going up for years and years and years.
I should just stay on the sidelines and not put money in no these pieces of data which anybody can look up and anybody can pull up a chart and see this has been the reality and as long as you believe that business will continue to grow people will continue to work in their own interests businesses will continue to find innovations and the economy will continue. you know people will continue to spend money then it makes no sense to not believe in these things and not want to buy and hold for the long term.
One last little tidbit on the market data that I found I wanted to look at so yes we know over 20 over a long enough period we saw not only recoveries from any sorts of crashes or bear markets but we also saw you know gains and doubles and triples. Well, I wanted just to look because you have time periods where maybe you bought at the top, and it took a long time for the market to recover back to that top right.
Let’s look at those time periods and see when that would have happened because obviously nobody likes to lose money. Nobody likes to see their capital in the rent. I looked at the top line, and I saw that it took until 2007 for that for the SP to recover after dropping after two after the year 2000 same thing happened from 2002 to 2009 and the same thing happened from 1973 to 1980.
I wasn’t out looking for a pattern like this, but I thought it was interesting that there were three seven-year time periods where buying at the absolute top still needed like seven years for the market to recover from that.
That’s obviously a long time to be in the red but again think of it as a long-term thing right we are putting money in the market there’s nobody that says you need to put all your money in at one time and not put any money and after that this is this is a habit just like Fitness, just like eating well, just like you know budgeting your money, just like driving safely these are all things you always do.
And so even looking at these worst-case scenarios to think that seven years is all it took for recovery this is the power of really being a long-term investor having a long mindset.
So yeah it looks like there is a big difference between holding for 15 to 20 years and holding for 5 to 7 years. You’ll tend to see if you look at kind of common knowledge or when people are on the internet and maybe spouting things that they call to be true. But maybe aren’t though they’ll say well maybe a long-term investments 5 to 7 years.
I think we need to look further than that and I think obviously coming from the perspective of a beginner and coming from perspectives of some of these starting young I see a lot of potentials and holding for long time periods holding for these 20 year time periods. Think that data obviously shows that, and I think even in these worst-case scenarios like I said before nobody said nobody says you need to put all your money in at the top and then nobody says you need to sell within a year two years three years four years five six or even seven.
When it finally breaks even it’s up to you how long you want to hold your money so if you know that eventually over a couple of decades you’re historically likely to double triple, quadruple your money. Then why would you sell at seven years why not continue to ride it out why not let the market do its thing.
So there’s a lot of power there, and this is a big reason why investing works and why a lot of people lose a lot of money in investing is because they don’t understand this about the market they don’t take the time to really examine well what’s the market done what is it done what do we expect they will continue to do, and so you know they try to shortcut things. They try to find little tricks and techniques and try the time the market and try to feel like they have some crystal ball that’s not what we do here we talk about long-term things.
We talk about foundational principles and this is a big reason why is because the data back it up and all it takes all it took what is a look at the chart that’s not even getting into the countless amounts of studies and research that have been done by people way smarter than me with way more experience than me.
You read enough investing books, and you’ll realize they all say the same thing hopefully this little snippet that we did here on the podcast hammers that home and it’s something you can verify right away.
And so I think it’s a really big key to why you want to buy and hold and if you think about like, we’ve talked about in the past couple episodes on back to the basics. When you’re buying the stock, you are buying part ownership of a business will grow if it’s a good business and it will compound your money for you, and it’s going to create wealth, and you don’t have to do much other than sitting there and buy.
Do its thing so the market has shown that it can do that individual businesses have shown that it can do that and so it only makes sense for you to get out of the way and let those things happen and so if you can understand that this is how the market has worked and this is how you can expect it to work in the future then you understand why we always talk about why it doesn’t matter when you get in. It doesn’t matter what’s going to happen tomorrow I don’t care what CNBC is talking about with the stocks or the economy or the macro or the micro or interest rates or any of this sort of stuff because I’m looking big-picture, and I have a firm understanding of how I expect the market to go how it’s gone for hundreds of years and how it’s gone for the past couple decades. And all of those things and using this knowledge you can feel confident and start buying stocks and start letting that money compound and not have to sit on the sidelines much longer.
So I think that’s one of the big principles that we all need to hone down on understand and apply when it comes to investing. That’s kind of how the price history as far as the SMP has gone maybe it makes sense now to look at what even the S&P; 500 means.
We haven’t covered this yeah we talked about how stocks kind of work through the exchanges but the S&P; 500 is 500 stocks that they made this formula and it’s a branch of McGraw-hill Publishing. They’re the ones who determine which stocks go into the S&P; 500 and so they made a formula and basically if a stock mix meets this criterion then it’ll be added to the index.
Something that I really wanted to make sure everybody understands when you look at the S&P; 500 you look at the Dow these are groups of stocks that other people have determined represent the market and so I think the S&P; is a good one, the Dow maybe not so much and we can get into that a little bit.
But what’s important to understand is both of these indexes are weighted so what that means is you know they’re going to add all the stock, so the SP 5-under is 500 stocks they’re going to add all the price action of all those stocks and combine it all and that’s what you’re going to see in the ticker.
So when you see that the S&P; 500 has gone up like a percent then you know that you know some of the stocks in the SP might have gone up 5% some might have gone up three somebody lost five but on average when you add all those up that’s what’s happened in the S&P.
Now that they’re weighted and what that means is the bigger stocks are going to have a bigger impact on the S&P; 500. So you think about like Apple Exxon Mobil those stocks when they move they’re going to move the SP and a higher they’re going to have a higher influence on the SP price because they are bigger companies.
They have higher market capitalizations and more capital inside them, so their price movements are going to move the SP kind of at a higher rate than then the smaller stocks will and that’s the same case with the Dow.
So that’s also something important to understand is just because you’re buying stocks in the S&P; or out of the SP doesn’t mean that you’re necessarily going to get the same kind of results as the S&P; 500.
For example, even if you bought every stock in the S&P; 500 and you bought one share of every of all 500 stocks. Your portfolio is not going to move in the same place as the S&P; because the S&P; is weighted and so even though in your portfolio 1% here and 2% there is going to have the same effect whether it’s Apple Exxon or a small company.
For the SP it’s different because they are weighted I guess a little bit of a tangent but something good to know so this is these are the two indexes that really represent what’s going on in the market, and this is a reason why the media and you know all the financial websites really refer to them as because of that.
So really they’re I mean something you can glean from that is there’s an advantage to buying smaller the SP will drop and when it drops a lot of the stocks that are being up to these higher valuations will kind of drop further than some of the smaller ones.
If you think about really buying low selling high, and this is something I want to cover more in the next episode but when you really buy stocks that aren’t bubbles versus having an index that has a lot of bubbles through the bigger bubble stocks that are really beat up at a high price for no reason for no good reason when they crash they’re really going to bring that index down.
But your stocks might not go down that much just because you didn’t buy bubble stocks so that’s a huge advantage that we can take advantage of and something that’s maybe a little bit more advanced and we’ve talked about before, and we’ll talk about next week. But keep that in mind that’s another great advantage you can have as an investor is just simply staying away from the bubble stocks and because the S&P; 500 is weighted, it’s going to drop at a much higher rate than your stocks might because your portfolio’s not weighted.
You have the SP you got the Dow you have bought and held I think the next thing to think about is diversification and dollar cost averaging. So obviously the diversification is key because you’re going to not every stock going to work in the way that you want, and there’s really no way to predict that you’re going to buy a winner every single time and also keep in mind that stocks going to now the S&P; as they get better or worse.
You don’t see huge turnover with the SP but you’ll tend to see a small handful maybe anywhere from one to five stocks may be up to ten some years that will either leave or join the SP so the S&P; 500 it’s kind of always self-regulating and keeping the good businesses in there you’re going to need to do that with your portfolio in the sense that by being diversified you are giving yourself more of the odds on your side.
When you look at the SP and we ever every data point I talked about coming up leading up to this today that’s all an average right, so some of the stocks on in the SP that has really carried the market that’s not the case for every stock and a lot of stocks have really helped the market crash.
That’s not the case for every stock either so by diversifying you’re getting closer to such a kind of what the market does obviously you’re not putting your all your eggs in one basket. That kind of makes sense to, and you just have to understand what are you going to put your financial future in the hands of a single company or are you going to do it in the business world in general.
You know as much as I love to believe in the different stocks that I use every day you know I have certain restaurants I like to go to I have certain products I like to use and everything looks like it the future always seems like it’s so predictable in the present. But as things turn out it never turns out that way so even though I love using Microsoft and I believe it’s been around for so long and I don’t see any reason why it would go away I’m sure a lot of people thought about that way about Blockbuster and just countless other examples.
So you want to believe in the business world in general really, and if you believe that business will continue tomorrow, we don’t know what those names will be that’s why we diversify, and we combine it with long-term with a long-term approach.
We’ve talked about before, and it’s a lot of kind of common knowledge as far as optimal diversification. You can look way back in the archives our first episode was about optimal diversification, but it tends to be around 15 to 20 stocks, and that’s kind of where I keep myself its good to expose yourself to different industries obviously different companies you know some industries and some stocks do better in certain market environments than others.
It’s always a good idea to average out your performance let business run its course and again stay out of the way but make sure you’re not putting all this blind hope in a single stock and just because you believe it doesn’t make it true. And so we want to limit our downside well yes it might cap our upside, but it’s going to be more towards again the things we can control. The things we know and the foundational principles that we know to be true just by looking at the data we talked about today. We know that if we can get closer to the market have a portfolio that’s close to the market then we can expect over a fifteen to twenty year or higher period to do well.
Obviously, let’s do that, and so you can obviously have different strategies to optimize which stocks you’re getting into really, but it’s really important to diversify make sure you have enough positions to let your exposed and let your ownership in businesses be focused on business and the economy in general. And not to concentrate on a certain stock or even industry that might not be around ten-twenty years from now.
Keep that in mind and the last thing we should talk about today is dollar cost averaging. This is a huge thing and a big thing that I talked about in seven steps understanding the stock market which is the e-book that I offer for free at stock market PDF com you probably hear over and over again in our episodes and it’s really key and Dave will let you kind of speak on dollar cost averaging a little bit like how do you implement it and why do you think it works for you and then maybe we can wrap up.
Dave: okay sounds great so dollar cost averaging the cool thing about it is it allows you to buy into stocks that you would not normally be able to throw a lot of money yet.
So let’s say that you are a beginning investor, and you want to start, but you don’t make a lot of money now. Dollar cost averaging allows you to put a small amount of money to work for you in the market at a rate that will compound over time.
Andrew likes to go with $150 mark and I think that’s a great place to start and you know you save that you know it’s like a savings account. So you take that hundred fifty dollars, and every month you buy something new it doesn’t have to buy something new but you can invest more money into the stock market and you can just take an example of let’s say you wanted to buy Apple the current price of Apple is 169 dollars so with $150 you can’t necessarily buy a full share and I know what Ally Invest I can buy partial shares of stocks and so with $150 I could buy a partial share of Apple.
Let’s say that I buy it for $150 this month, and I get you know a partial share of it the next month let’s say that some bad news happen which actually has happened recently which has caused the price to drop to 169 with the allegations of the battery and the things that are going on with that. It’s driven the price down a little bit let’s say that continues the next month and you want to buy it some more of Apple the next month.
Let’s say it drops to 142 dollars now you can buy more than a share and so every single month that you continue to invest in that company over the year you’re going to spend $150 per month and you’re going to buy shares in half every single month and because the price of that stock is going to fluctuate every month it allows you to buy more or fewer shares of that company which will compound over time. And especially a company that pays dividends which is that endure a nice favorite thing to talk about and we’ll discuss that more next week.
These things will allow you to you know to get more money into the market and continue to build your wealth, and the great thing about dollar cost averaging is it does allow you to buy into the market at you know levels that us mere mortals can invest in.
So you know the people that are making half a million a year or more you know they’re you know doctors you know lawyers people of that ilk they can afford to drop you know big hunks of money twenty thousand fifty thousand bucks into the market at a time if they want to and they can pick and choose when they buy things and this that error thing. But dollar cost averaging is a great way to help take a smaller amount of money and invest it into the stock market every single month over the course of a long period of time you know with you having buying dividend-paying stocks all that is going to compound and compel the compound to compound and that’s how you build wealth in the stock market.
Not all of us can be Warren Buffett and have five hundred sixty-nine billion dollars laying around to you know go out and buy a company. So this is the way we do it, and it’s a great way to you know invest and make your money work for you.
If you take the one hundred fifty dollars just in the comparison and you put that in a bank account right now in a savings account let’s say most large banks are going to be paying less than 1% on that money 1% less than 1%. So that means at the end of the year your going to be lucky if you make a couple of bucks by all that money that you’ve invested over the course of the year.
Now what’s a dollar cost averaging you’re going to be putting that money in every single month, and if that stock goes up 5% and you take away the fees that you’ve had to use to invest over the course of the month you could easily make 2 or 3% over the course of the year and that’s just being conservative. And so there is great attention to using the stock market to help you grow your wealth.
Andrew: Yeah and what’s so you know obviously it gives you great like Dave said it gives you great potential and the ability to get out there right away really. It also keeps you away from trying to time the market too much so if you’re getting your dollar cost averaging means you’re buying a certain amount every single month and like I said I’d like to do one hundred fifty. By doing that you’re always in the market and you’re never timing it because if you’re buying every month at the end of the day your always picking up more shares in the matter if the markets up no matter where the markets down.
And so by doing that you’re taking a lot of the risk of maybe buying on the top as we said and even though might not matter you’re also averaging and buying and at the bottom too. So it’s just going to boost and beef up your returns the longer and longer you do it.
And obviously setting habits is another great way to really cement good results and by sending habits and keeping your budget low and always putting money in that’s it’s going to be a fantastic way to see your wealth grow just like the market does and it’s really going to compound in a really nice way, and that’s what’s really that’s what really makes the market beautiful and what makes investing so great is compounding.
I didn’t even go into the numbers and are also really basically you can look up where it says you know over 90 to 90 year period you can look at the sp500, and you can see its average ten percent analyzed a year. You can look at like there was a study by Merrill Lynch that looked at value stocks and saw those averaged 17 percent a year over 90 year period.
There are all those other types of studies there and so when you’re investing and when you’re looking at making more money the next thing to understand is compound interest and annual returns and what that means for your money so I always talk about on the podcast how people should use a compound interest calculate their type in their numbers and see where that gets you I talked about it over and over and over again, and it’s really because I think that’s something that makes it click for you when you see a graph. You know we talk about the stock market going from left to right from bottom left top right. But compound interest curve it does the same thing but it skyrockets up we’re talking about exponential growth we’re talking about money getting added to your account and the longer it happens the faster and faster gets added so you might see little additions in the beginning, and it compounds into massive additions in there at the tail end.
And so why I like one hundred and fifty dollars a month as an example is because taking that over and you know plugging into a compound interest calculator and plugging in eleven percent as your return. So remember stock market ten percent average returns 11 percent very conservative just to say if we can outperform by one percent a year by picking good stocks which are what we try to do on the podcast.
Take one hundred fifty dollars a month one percent one percent over the average for a year 11 percent a year and look at a forty year period and just let the money grow. Let the businesses do its job and let the money compound what are the results you get over a million dollars in that period. So really we’re talking about what the price of a cell phone bill and eventually becoming a millionaire because of that and again this is all very conservative. This we don’t know what the market does we don’t know what your skills are as a stock picker we don’t even know if you can afford to invest more and I have a lot of readers listeners a letter subscribers VTI clients all telling me that they’re investing more than 150 and they’re getting great results, so you’re ending results can be a lot greater than even these conservative examples that I always give.
That’s why I always recommend using a compound interest calculator and just understanding that these basic principles apply to us all. But the results can vary, and it could be again I like to stay conservative because I think that that allows for everybody to be included. But we could be talking about serious millionaire’s serious wealth being grown for the next couple decades, and there’s just a lot of potential.
You need to understand compound interest you need to plug it into a calculator for yourself if you don’t understand it and you need to understand that on its most basic level it is putting your money to work. I think we talked about this a little bit of having your money as their little workers that they’re all creating more wealth for you and so as your money earns money and you reinvest that money. not only do you have the initial amount that you’re earning you have a dollar cost averaging which is another chunk of money that you’re adding the next month that’s going to earn more money. but then you have these little these little pieces of money that were earned already, and you pile those in, and now that earns more money, and so that’s where you get explosive growth that’s where you get exponential growth is because all these things add up over time. and the more, the more you pile in, the more time goes on and the longer time is allowed to work and you know even businesses you might you might buy stocks that you might have a business that’s like the next game changer and it could be compounding your wealth much faster than 10 or 11 percent. we could be talking about twenty percent forty percent you know maybe seventeen to twenty percent a year that’s not that’s not unrealistic to see a stock do that.
And so now you have money that you put in and there’s now compounding a twenty percent and then your reinvesting that and compounding of another 20% and you just see there’s just so much explosive growth and potential that that can really happen when you apply a compound interest when you apply dollar-cost averaging when you apply long term investing it’s just so much potential, and I think again it’s it can get lost because when people jump into the markets again they see the short term they see they see a stock that maybe could double in a short amount of time and they think that’s the key to making money and it’s really not.
It’s going based on averages going based on history going based on the things that we can expect to happen the things that we’ve seen happen and putting our bets quote-unquote putting our bets on that. and so utilizing long-term investing means being able to smooth out all the business cycles using diversification is another way of doing that using dollar cost averaging is another way of smoothing out cycles and always adding money and always growing your wealth and the final key to that is compound interest.
And so when you have money that’s making money and then the new money is making money and all money continues to make money and then you have more new money and then that new money is making new money because the stock market’s growing it and yours reinvesting it just balloons okay you just have you have like a like a like a little pun, and it just grows out or the way the universe just grows out with light right and that that’s just what you have and there’s just so many different metaphors.
You have the snowball metaphor where you know money accumulates, and it’s just like pushing a snowball down the hill at first it takes a lot of effort, and then as the snowball gets down the hill it collects more and more snow and the amount of snow it collects grows and accelerates and soon you don’t even have to touch the snowball, and that continues to roll down the hill.
All these different metaphors for compound interest and they still don’t give the concept of enough justice, and that’s really where the key to all of this stuff is, and this is why you want to put your money to work is because it can create small amounts of wealth into huge amounts of wealth.
I guess I just can’t stress enough trying to compound interest calculator for yourself everybody’s going to have a different period everybody’s going to have a different amount that they can invest, and everybody has a different amount of skill level when it comes to picking those stocks.
Definitely kind of play with that if you don’t do anything else you know to play with that and see if you know all of a sudden feel more confident that yes this is why I’m going to win in the stock market this is why investing is so powerful. it’s not because I’m the next Warren Buffett it’s not because I’m going to pick the right stocks somehow it’s not even because you know I’m going to because I was born at a certain period and you know I just happened to buy in before bull market.
You really don’t have to worry about any of that if you get all of the principles we talked about today in set in place then it becomes something where it automatically all works together for you, and that’s what’s going to be your key to success and it’s really something that people honestly just don’t take the time to like I said at the beginning they don’t take the time to master it so they might like to skip it or gloss it over and it just makes a huge impact.
It’s one of those things that just works in the background and you don’t realize until the time is done that man if I would have just done this and just been patient and just have the right long-term approach my results could have been so different.
Don’t let that don’t let the non-flashiness of these concepts kind of blow by you and really take them to heart and use them in your own approaches and then at the end of the day it’s all the other stuff that you know 90% of the concerns I get through email from people doesn’t matter when you understand these things and when you put into place just automatically puts the business world on your side and lets business grow your money and that’s when investing is and that’s what we need to understand.
Dave: those are all excellent points and you know I think you know to continue to hammer what Andrew was saying home Warren Buffett didn’t achieve his superstar celebrity investor stardom until about 20 years ago he’s been doing it for about 50 years and 50 years plus and you know granted he’s the best investor in our generation and arguably the best investor ever, and he’s made countless hundreds of millions of billions of dollars.
But I think the point that I’m trying to make with this example is that he was a buy-and-hold investor, and he’s been patient he’s been on the market for a really long time and he understood the impact of compound interest and the last thing that I want to say about compound interest is that a very smart man Albert Einstein called the eighth wonder of the world and it truly is, and it’s something that’s a shame that it’s not taught in schools, and the effectiveness is staggering.
And my mentor was talking about the biggest thing that we can do for ourselves to help ourselves our future selves is to let our money work for us instead of us working for our money. We need to have our money working for us and compound interest, and the best thing in a stock market is one of the greatest ways to do it, and it’s one of the greatest forms of passive investing that you can come across especially with dividend investing.
So I think that’s going to wrap it up for us for tonight I appreciate you guys listening hope you enjoyed our additional comments on back to basics next week we’re going to wrap it up with our final discussion we teased on it a little bit, and we’ll talk to you guys next week you guys have a great week.