Essentials of Powerful Long-Term Investing

“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:

1. Dividends

Owning stock often means collecting a cash payment on a quarterly basis, typically directly back into your investment account. It’s calculated as a number of cents multiplied by the number of shares you own.

So, if you own 100 shares of a stock that pays a $1.50 per share annual dividend, that’s 100 times 150 cents ($150) that you are free to spend or reinvest.

Now, if you know the price of the stock, you can calculate the yield as a percent. In the example above, if the stock is priced at $25, the yield is 6% ($1.50/25 = 0.06). Imagine you buy 1,000 shares. Your money is now paying you $1,500 as annual income to spend or reinvest. Let’s double check that: $25,000 x 6% = $1,500.

That’s the “power” part of dividends. Retaining those dividends and reinvesting them greatly magnifies wealth over time.

2. Interest

If you own bonds, you are likewise paid an income as a fixed yield each and every year own own the bond. U.S. Treasury bonds are likely to pay the least, corporate bonds more and foreign government bonds the most.

Of course, the more you earn the more risk you are taking that the secondary market for your bonds will dry up (should you need to sell) or that a given issuer will decided not to pay. It’s rare but it happens.

Nevertheless, steady bond income works like dividends to put money in your pocket to reinvest as you wish.

3. Appreciation

Both stocks and bonds can appreciate in value, that is, it’s possible that a buyer in the future will pay you a premium to own your existing stock or bond position. Stocks and bonds can also lose value, of course, but a long-term position in either market stands a reasonable chance of becoming more valuable in time.

How do you realize the “power” of appreciation? By rebalancing. Owning a selection of stocks and bonds across multiple markets gives you a chance to sell those that have temporarily risen in value and using the resulting cash to buy any that have temporarily declined.

The trick is not to get emotional about the process. People sometimes identify too closely with a single stock or bond holding and it pains them to let it go, even when it has risen out of proportion to the rest of the market and often even if it has fallen.

But that’s an important step to take, one that a well-designed portfolio will provide. Automating the process and deemphasizing the personal connections you might have to an investment are a huge part of how portfolios cement incremental gains over time. And that’s power investing at its best.