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:
- Appreciation of the stock price; you bought it for $9/share now its worth $10/share
- 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.
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