Personal Finance & Money Asked by Markinson on January 8, 2021
I’ve read Einsteins quote stating “The most powerful force in the universe is compound interest.” However, everywhere I read this is basically only possible with dividend paying stocks and then applying a dividend reinvestment plan.
Is there a re-investing strategy like this for non-dividend paying mutual funds (or even non-dividend paying stock)? I figured that the only way would be to sell all your funds and then buy x+1 funds again, but this would cause a big loss because of transaction costs from the broker.
I think you are overcomplicating things.
In the case of a stock / fund which pays no dividends / interest, your investment automatically 'reinvests' any growth directly into the value of a stock.
Assume you buy $10k of shares in a company which pays no dividends.
Now assume that for the next ten years, each year the company grows in value by 10%. First, your shares are worth 11k. Then 12.1k. Then 13.31k... In 10 years, your shares would be worth 25.9k! This is equal to 159% growth over 10 years - an average of 15.9% growth per year, even though growth was only 10% per year. This is the power of compounding. If you held the same investment for 30 years, it would be worth 175k, which is growth of 1,600% - an average of 164% per year!
If you had a stock that paid everything as dividends, and then you rebought shares [assuming no transaction fees], then this compounding impact would theoretically be exactly the same.
Correct answer by Grade 'Eh' Bacon on January 8, 2021
Answer above by Grade "Eh" Bacon is misleading.
The "Annual Return" of a stock, as often reported by index or fund companies, is calculated based on the principal of Compound Annual Growth Rate. This calculation only uses 3 values - Your stock purchase price, stock sale price and the number of years you held the stock. In other words, the annual return (or sometimes misleadingly called compound annual return) is ONLY calculated in hindsight.
The Annual Growth Rate of a stock is the gain of the stock in that year, expressed in the form of compound interest. But it's very different from the compound interest, say, earned in a savings account. Because while a bank can guarantee interest payment (say 3%) and you can use the calculation of annual 3% compounding interest to calculate your gain, stocks rise and fall and never guarantee their return. That's why I feel that Grade Eh Bacon's answer above is misleading because you can't apply that notion to stocks.
Check out this article on Investopedia https://www.investopedia.com/terms/a/annual-return.asp#:~:text=Annual%20Returns%20on%20Stocks,a%20designated%20period%20of%20time.&text=The%20simple%20return%20is%20just,divided%20by%20the%20purchase%20price.
Answered by RitaFo on January 8, 2021
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