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PF Investing Club

  1. Jun 28, 2017 #1
    This thread was spawned off
    https://www.physicsforums.com/threads/financial-knowledge-all-adults-should-know.916758/

    Do not act on any financial advice here before doing due diligence and meeting with a qualified financial advisor.

    hmmm I guess I am missing something. If I buy 1 share for $10 and if over a few years it goes up by 10% then I have $11. Where is the compounding?
     
    Last edited: Jun 28, 2017
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  3. Jun 28, 2017 #2

    Vanadium 50

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    So let's take a look at that. The worst decade for stocks was 1928-1938, with an annual return of -1.3%. This is the only 10-year period in the history of the Dow where the return was negative. The worst 20-year period (1928-1948) had an annual return of 2.5%. The worst 35-year period (1906-1941) had an annual return of 6.1%. The worst 50-year period was (1928-1978) had an annual return of 6.8%.

    So the risk you have with buying stocks, and as you see, there is risk, is reduced the longer you own it. Furthermore, most people don't buy stocks all at once and hold them for decades. They buy continuously. That also reduces risk - when stocks go down, you buy more shares for the same money, and when they go back up, you realize more gains because you have more shares. This goes by the name of dollar cost averaging. It also shows that stocks are risky if you need the money a year or two down the road.

    Low cost index funds, with dividend reinvestment (the equivalent of compound interest for an instrument that doesn't exactly produce interest), are a simple and diversified way to take advantage of this. Vanguard 500, for example, mirrors the S&P 500 for an expense ratio of 0.14% - that is, you need to drop those rates of return by 0.14% to cover the fees. So 6.1% becomes 5.96%. This particular fund has an initial investment requirement of $3000. This may seem like a lot, but if you don't have $3000, your first priority should be to beef up your savings. You need a safety net now more than you need returns down the road.
     
    Last edited: Jun 29, 2017
  4. Jun 28, 2017 #3

    Vanadium 50

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    The stock likely paid dividends. If you reinvest them, there's your compounding.
     
  5. Jun 28, 2017 #4

    russ_watters

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    The $11 is your new principal and the growth is calculated against that new principal annually. You don't gain 8% of your original investment per year, you gain 8% of your current principal per year.
     
  6. Jun 28, 2017 #5
    Are we talking the market as a whole or for individual stocks? Looking at my positions with the stocks I own I don't see this as the case. Perhaps I should just go into the Vanguard 500 where I'll be given 6-8% on average and then see compounding.
     
  7. Jun 28, 2017 #6

    russ_watters

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    As a whole (S&P 500 is good), the average is about 8%. As V50 said, the WORST it has ever done over a retirement account span of time (50yrs) is 7% per year.
     
  8. Jun 28, 2017 #7
    Amazon and Google are obviously giants, but they now have extremely steep prices. Would they still be a buy if you are looking at holding them for 20-30 years? Or is it better to play completely safe and throw everything into Vanguard 500? So hold tech giants for 30 years or Van500?
     
  9. Jun 28, 2017 #8

    Vanadium 50

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    But the best (1949-1999) is only 12.8%. Long period investing reduces the risk of losing your shirt, but it also reduces the chances of a windfall. Something called a diversification return (analyzed in some detail by physicist Scott Willenbrock) helps with this.

    Greg, the way this "compounding" works is suppose you bought your stock at $10. The next year it's at $9, the year after that, $12. Then $11, and so on, and after 20 years it's at $67. That works out to a 10% average rate of return because (1+10%)^20 = 67/10. It's an equivalent compound interest for an instrument that doesn't really have interest. There is an expectation that this will happen at some level for a profitable corporation. The company either pays a dividend, which you then reinvest (like compound interest) or the company re-invests the profit within the company, which is essentially the same as a reinvested dividend.
     
  10. Jun 28, 2017 #9
    Interesting! That makes sense to me, thanks! So, in a way growth stocks are riskier because you are betting they use your "dividend" wisely.
     
  11. Jun 28, 2017 #10

    Vanadium 50

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    Most of Amazon and Google's growth has already happened, so you shouldn't expect historical returns from them. Putting money in only two companies has inherent risk to it - there were times when WorldCom, Enron and WaMu looked like great deals (and Theranos would have too, had they been public). Now, not so much. What you would really like to do is to have invested in Amazon or Google when they were smaller. Can't do that, but maybe you can do that for the next Amazon.

    One way to attempt that is to invest in smaller cap stocks, for example, the Russell 2000 index. The idea is that before Google was a big company, it was a small company, so investing in many small companies is a way to capture some of this growth, and by investing in many reduces the risk. Conventional wisdom is that the Russell 2000 has slightly better returns than the S&P 500, but is slightly more volatile and thus slightly more risky.

    My strategy has been to avoid trying to strike it rich, and get steady, decent returns year in and year out.
     
  12. Jun 28, 2017 #11

    strangerep

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    I get the feeling you could benefit from reading more about low-cost diversified index funds. Vanguard offers quite a lot of literature on this if you look on their website. I've been invested with them for many, many years, but there are now quite a few other funds of this type, including so-called ETFs (exchange-traded funds).

    When planning a long term portfolio, the most important thing is to set your proportions of asset classes correctly for your investment timeframe. E.g., if you're only invested in stocks (whether US-based or international), that's still really just 1 asset class. The main other asset class is bonds. (Maybe property as well, but that's far less liquid, hence hard to trade unless you use a listed property investment fund, but those tend to behave more like shares than property.) I.e., focus on broad asset classes, not individual stocks/bonds.

    For examples of this, take a look at Vanguard's diversified funds -- not just their stocks-only, or bonds-only funds. For a long term (retirement-like) strategy, and minimum rule-of-thumb is to take your age, and have no more than that (as a percentage) in income assets (with the rest in income assets, i.e., bonds). So a young person should be in a high-growth fund, whereas an old person should be more weighted towards income assets.

    Btw, Vanguard's diversified funds invest in major markets all over the world, so that gives an extra degree of diversification. They use "passive investing" -- meaning that when one asset class starts to become valued higher than its target percentage range in the fund, they sell some of those assets and buy other lower-valued asset classes. Hence they achieve an automatic mechanism of sell-high/buy-low just by rebalancing their portfolio asset class proportions. A similar thing can be done using the ordinary cash flow through the fund. The beauty of this is that you don't need to rely on expert stocking picking.
     
    Last edited: Jun 29, 2017
  13. Jun 28, 2017 #12

    Astronuc

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    Investopedia has a good article on comparing ETFs. One should looks at fees.
    http://www.investopedia.com/article...-vs-russell-2000-etf-which-should-you-get.asp
    http://www.investopedia.com/articles/investing/040516/10-cheapest-vanguard-etfs-voo-vti.asp

    On individual stocks, one should look at P/E and EPS, as well as the overall market and sectors, i.e., do one's homework.

    One can look at dividends and/or appreciation potential. With good dividends of a few percent or more, once can do dividend reinvestment.
     
    Last edited: Jun 28, 2017
  14. Jun 28, 2017 #13
  15. Jun 29, 2017 #14

    Imager

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    @Vanadium 50,

    Excellent comments. Most of the staff in Finance Departments that I have worked in could not have explained things so well!
     
  16. Jun 29, 2017 #15
    Hey, Greg

    Are you proposing a thread for any and all things investing related in the OP? Or, is this thread devoted to some very specific questions/issues (raised in my other thread)?

    I'd love to have a one-stop-shop type of thread for all investing chat. It'd be fun and education, as I'm just getting started and learning. Count me in if it's an investing mega-thread! :smile:
     
  17. Jun 29, 2017 #16

    Vanadium 50

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    Strangerep mentions diversification. He's right, but I think that opens up an even more fundamental question: "When do you need the money?"

    If I needed the money next year, I sure wouldn't put it in stocks. Sure, the average return is maybe 10%, but there are some horrible negative outliers. A 1 year treasury would get me 1.22%. I can probably find a 1.25% CD- whether that's better or worse depends on your state's income tax. I'd definitely go for that over buying a mutual fund, and especially over buying a single stock.

    This in turn brings up the concept of risk. At it's core, investing is about maximizing return for a given amount of risk (or equivalently, minimizing risk for a given return). If I need a $10,000 a year from now, investing $9900 in a CD today has less risk than investing $9000 in Amazon today. As an investor, it's my job to decide if the reduced risk is worth the $900. This is where diversification comes in - it's a key tool in adjusting risk.
     
  18. Jun 29, 2017 #17

    jtbell

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    Reinvested dividends. The Vanguard Total Stock Market Index fund currently yields about 1.8% in dividends. Vanguard Total Bond Market currently yields about 2.3%. With a stock fund you also have capital appreciation (increase in share price), which of course varies a lot and is negative in some years.
     
  19. Jun 29, 2017 #18

    jtbell

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    Dividends are not "free money." A company's profits can be either distributed to shareholders as dividends, or reinvested in the company, which tends to increase the stock price, or held as cash reserves, which also tends to increase the stock price. For investors, this produces a tradeoff between dividends and capital gains. This isn't easy to see with individual stocks because of the normal random variation in stock prices. However, if you compare an index fund that "specializes" in high-dividend stocks with a total market index fund:

    vtsmx-vhdyx.gif

    This is a "growth chart" that starts with $10K of each fund, and assumes dividends are reinvested.

    The dark blue line is Vanguard Total Stock Market Index (VTSMX), which currently yields about 1.8% in dividends. The yellow line is Vanguard High Dividend Yield Index (VHDYX) which currently yields about 3.0% in dividends. How much difference do you see? And when they are noticeably different, which one comes out on top?
     
  20. Jun 29, 2017 #19
    Any type of specific investing questions or commentary, not just general financial advice as the other thread is about.
     
  21. Jun 29, 2017 #20
    Is that technically compounding, though?

    Also, you're right that you can lose money too! Although, index funds or slow growth funds/stocks are "safe."

    Here's a question:

    Assuming your non-stock market financial situation is solid (you have a decent stable income, low to zero debt, no crazy liabilities, etc.), is there any reason to not reinvest dividends in a good fund/stock?
     
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