Yahoo Finance My best investment decision – and why it’s not too late for you
Nicole invested in shares from a young age but that wasn't her best investment decision.
I started investing when I was 18. I was interested but by no means in the know.
Back then, all I knew was I wanted to turn the little bit of money I was earning into more. So I stashed, rather than splashed, just a bit of it.
I began by investing in managed funds of shares chosen by someone else - – it was one of the only options for novices in those days. There is a far better option these days, but I’ll get to that shortly.
Vitally, I ticked the box that read: “reinvest distributions”. I didn’t know what it meant. I just knew I wanted to keep my money in there.
A few years – and a bit more investment experience – later, I graduated to buying the shares themselves, myself. (This used to cost a lot up front. It’s so much easier now with online, cheap-as-chips brokers.)
And I ticked the “reinvest dividends” box - it was a habit now.
Here’s why ticking those random boxes – and not the actual shares and funds I bought – was my best-ever investment decision.
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My best-ever investment decision
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Check out this chart of the share market.
The bottom line is how the value of Australia’s largest 200 shares has grown – despite all the short-term ups and downs – over the past 10 years.
The top line is how money invested in those shares has grown, where an investor has also reinvested the income those shares pay.
Since its inception in 2000, the S&P/ASX200 Index of shares has grown 4 per cent a year. By comparison, the S&P/ASX 200 Accumulation Index, which includes dividends, has put on 8.50 per cent a year. In other words, investors have made more than twice as much every single year.
Why is the income so powerful? Because, from the very second dividend (from shares) or distribution (from share funds), you are earning money on money you haven’t had to save yourself.
You’re earning on earnings.
This is what’s known as ‘compounding’. I call it the ‘snowball of investment success’ and Albert Einstein went so far as to dub it the ‘Eighth Wonder of the World’.
Whether urban legend or exact truth, it’s understood Einstein said: “He [or she] who understands compound interest earns it; he or she who doesn’t understand it, pays it.”
That’s saving or investing, where you (hopefully) make money, versus borrowing, where you (definitely) pay extra.
How reinvestment sends returns stratospheric
Dividend Reinvestment Plans or Distribution Reinvestment Plans (DRPs) let you compound your returns – so very easily. Tick that magic box and the income a company or fund that you own pays (usually every six months) is automatically reinvested into additional shares.
You can sometimes opt for just partial participation if you need the cash itself. But I urge you to try to ‘roll it up’ instead.
Think about it: the more shares you own, the more dividends you will get next time. And the more shares you own, the more you benefit from growth in the value of those shares.
It’s also even better than that because there are no brokerage fees when you add shares via a DRP, meaning lower investment costs and higher returns.
Perhaps best of all, because it’s an automatic process, you don't need to actively manage your portfolio to ensure you’re fully invested either. It all happens in the background of your busy life.
The far better way to invest today
So, what is the far better way available today for a novice investor to get started in the share market?
Most managed funds – you can still get them – are expensive. You will pay high management costs for those that are ‘actively’ managed, where analysts pick the stocks they think are good investments.
As an alternative, you can now simply ‘buy the market’ through what is called an exchange-traded fund (ETF).
That means you get a small slice of the exact companies that make up a market index, like the S&P/ASX200. You can also choose to invest in a particular market sector – there are 11, including financials, industrials, health care and materials – or even another country’s market.
You buy ETFs just like a normal share. So, initially, you just get them from a bargain online broker.
Naturally, your money can’t outperform the market but you will receive the exact returns an index makes (minus a tiny management cost – because the fund is not actively managed).
And do your future self a massive favour and tick the Dividend Reinvestment Plan box.
The information provided on this website is general in nature only and does not constitute financial advice. Before acting on any information, you should consider your personal objectives, financial situation or needs.
