What Most Investors Don’t Realize About How To Make money In The Market

What Most Investors Don’t Realize About How To Make money In The Market

By: Corey Philip
Updated: July 31, 2016

In April 2009, as a 19 year old I took $2,000 and opened a scottrade account.  I knew the market was down, and that now was ‘the time to buy’.  With only the intuition in my head, I bought SPY — the good ole SP500 index fund.  A few months later Scottrade sent me a dividend check.  I took my few dollar check and deposited cashed.  I got a few more dividend checks and cashed those, before selling my shares in 3 years or so.

If you ask someone how stocks make money they will typically tell you it comes from 2 things:

  1. Appreciation of the stock price; you bought it for $9/share now its worth $10/share
  2. Dividends; profits distributed from the company

That is true at a granular level, but in the big picture there is another layer that most investors don’t realize.  To make the most of a position and get the total return for it, you as an investor, should keep take those dividend checks and re-invest in the same position.

Its called cumulative returns; the returns you obtain by re-investing all your profits into the asset that generated them.  Cumulative returns are a key function of any long term investment.  

sp500 total return vs price return
If you reinvested all your dividends, you would be left with the green line. If you spent your little dividend checks as they came in you would have the orange line. Ignore the yellow line.

Lets take a at how much more money I would have I would’ve kept investing dividends from my 2009 investment.  Had I invested $10,000 and spent the mere peanuts of a dividend, it would now be worth $27,136.96 (the price return).  Had I been smart and re-invested those dividends it would now be worth $31,433.09 (the total return).  A material difference.

This might sound amateur to many who read this, but I’m sure just as many aren’t aware of the value of cumulative returns.  I knew of the power of compounded interest but all through my bachelors degree, with a major in accounting, and a couple finance course I was never introduced to the principle of cumulative returns.  It wasn’t until I was reading the book ‘Good To Great‘ that I became aware of the cumulative returns.

Martin Shkrelli, the pharma-bro who formerly ran a headge fund isn’t even aware of cumulative returns either.  I was once briefly tuned in to a webcast he did on YouTube when he was talking about stocks.  He said, and wrote a white board style program that “stocks don’t always go up” and then proceeded to make his point with a SP 500 price return index, SPX.  I was quite shocked someone as ‘educated’ as him was presenting this.  It just goes to show, that many people don’t know

During periods of the rough decade of the 2000s price return did go negative while total return was positive.
During periods of the rough decade of the 2000s price return did go negative while total return was positive.

 

Corey Philip
July 31, 2016
Corey Philip

Founder of a home service / specialty trade contracting company (think patio's and deck) with a focus on customer experience. Quantitative investor. Data driven marketer. Runner.