“It takes money to make money.” You know the saying, but when it comes to investing the truth is a bit more complex. Yes, it takes initial capital to make an investment. Most brokerages won’t open an account with less than $1,000 as the opening balance, which is understandable. But once you have that seed money invested, and especially if you set up automatic deductions to add to the balance, then the ball is rolling. What happens next is a big driver of your long-term investing success. Properly invested, that cash begins to generate growth three ways.
Dividends. According to a recent Forbes article, titled "Essentials of Powerful Long-Term Investing," owning stock can often mean collecting a quarterly cash payment. This is usually just reinvested into your account and is calculated as a number of cents multiplied by the number of shares you own. For example, if you own 100 shares of a stock that pays a $1.50 per share as an annual dividend, that is 100 times 150 cents or $150 that you have to spend or reinvest. If you know the price of the stock, you can calculate the yield as a percent. The stock in our example is priced at $25, the yield is 6% ($1.50/25 = 0.06). Retaining those dividends and reinvesting them greatly magnifies wealth in the long run.
Interest. If you are a bond owner, you also are paid an annual income as a fixed yield every year you own the bond. U.S. Treasury bonds typically pay the least, corporate bonds more and foreign government bonds generally pay the most. The greater the risk, the greater the potential pay-off. The more you earn, the more risk you are taking that the secondary market for your bonds will dry up (if you need to sell) or, in the rare instance, that an issuer may decide not to pay. Steady bond income works like dividends to put money in your pocket to reinvest where you like.
Appreciation. Both stocks and bonds can appreciate in value—a buyer in the future may pay you a premium to own your existing stock or bond position. However, stocks and bonds can also lose value, but investing long-term in either typically will see them increase in value over time. The original article suggests owning a selection of stocks and bonds across multiple markets to allow you the flexibility to sell those that have temporarily risen in value and using the resulting cash to buy any that have temporarily declined.
According to the Forbes article,the trick is not to get emotional about the process. The article further suggests automating the process and deemphasizing the personal connections you might have to an investment.
Reference: Forbes (May 30, 2014) "Essentials of Powerful Long-Term Investing"