The stock market can be a scary place, you might think you can lose all of your money based on some familial anecdote that your father or uncle told you about. “In 2008, I lost it all, the stock market is just a casino”. But there are lots of ways to overcome the fear of investing in the stock market. I bet you’ve heard that before from someone, but did you ask, what were you invested in? What did you do in the markets? Oftentimes it’s an investment in a smaller get rich quick scheme stock with a high valuation and nothing to show for it. Or… The holding period didn’t extend on the good stocks.
What if you were long SPY (S&P 500 ETF) going into 2008, and or AAPL (Apple Inc). Let’s say you bought the SPY in 2005.
200 shares of SPY on January 03, 2005, for $122 a share (total value of $24,400, your full retirement). By October 2007, your investment was worth ($31,400 at $157 a share, 29% gain). By March 2009, the investment was now worth ($13,600 down 45% of the original investment). Now you have two options:
1. Pull out of the market and take the loss and go back to saving your paychecks in a savings account.
2. Add more into the position because you’re investing in the overall US economy and monetary policy.
If you had held your investment, by January 2022, the position would be worth ($94,000 at $470 a share, or 285% gain)
If you added another 200 shares at $70, you’d have 400 shares at $96 a share. In 2022, worth $149,600 or 513% ROI. NOW, consider this: you only ADDED twice into a long-term position that you have held for just over a decade. Now consider adding multiple times throughout the year, it is a RETIREMENT fund, you’re investing no trading. That is the power of compounding gains.
This article is to explain what the power of investing in the stock market the smart way can do for your long-term wealth. How to break the fear of investing in the stock market, rather than thinking “I can lose it all” think “what will this be worth in 10-15 years”.
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What is compounding investing?
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What are good investments vs bad investments?
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Breaking the fear of investing in the stock market
1. What is Compounding Investing?
We all have to be familiar with the effect of compounding to break the fear in the market as we mentioned in our last paragraph. It doesn’t matter TOO much when you get in, it’s how long you can hold for. Now when and timing can be a huge advantage. This is really hard to do, however.
The effect of compounding is such that the earnings of an asset are reinvested to generate additional gains and earnings over time. This process is done continuously. The earnings of an asset can be taken from the capital gains or interest (dividend). There is another way as well, by continuously adding funds into the asset as the asset grows. Yes, the overall average cost will be higher however you will have more shares and the price will be higher by the end of your investment. It isn’t like you’re adding each day, the additions are split up by time. The premise of this effect is that there will be more money in the principle if the interest or gains are reinvested and that a larger amount will create larger monetary gains.
You can use the basic time-value of money to understand what the gains of the compounding effect will be on your interest growth.
For example, let’s take the basic dividend stocks into account, where you will get a quarterly dividend each quarter. One of the most consistent with a larger dividend is MO (Altria). Now keep in mind that dividends change. Since 2011, the dividend on MO has changed a lot from a 3% starting yield, rising up to 8% and falling from there. Now instead of calculating each dividend compounded, I’m going to do a huge financial no-no just to get a concrete yield number, average out the yields over the last 40 quarters or so and weigh them. This isn’t the correct way but it will give us a round ballpark figure.
The average we’re going to use for the dividend yield on MO is about 5.3% over the last 10 years. Let’s use our time value of money. Remember this is annual, we can turn it into quarterly and use that to calculate but let’s not overcomplicate.
Starting in 2011 with a $15,000 investment in MO. Without adding anything but only reinvesting the dividends:
PV: -$15,000
I/Y: 5.3%
N: 11
PMT: 0
CPT: FV
FV which is the future value is $26,473. Which is a gain of 76% on ONLY the interest. This isn’t inclusive of the capital gains from the share gains. In 2011 January. The MO shares were trading for $24.70 each, and in January 2022 trading for $49.35. Which is a capital gain of 99%.
With interest and capital gains, this position will be worth well over 160% gain in 10 years. Which is an average of 16% annually. With the power of compounding.
Now there were ups and downs in the stock, along with the dividend but the dividend kept coming and if you had confidence in the stock, then it was a good hold in itself.
Below is the image of MO from 2011 to 2022.
2. What Are Good Investments vs Bad Investments?
Have you ever heard of the argument, value vs growth, active management vs passive management? There are such things as well-proven investments vs bad ones and a lot of people who have been burned in the stock market have developed fear just from this.
Finding a stock that was once up 200% and is now down 90% from the highs isn’t guaranteed to pop back up to the highs. Why do you think it dropped so much from those highs? Because it shouldn’t have been up 200%, to begin with. Look at Cathie Wood and the growth pop. These are growth names for a reason, they’re not proven to have stability. Some may hit, but most will not.
Take into consideration what we could call a growth ETF vs a value ETF.
Value ETFs: VTV (Vanguard) & SPLV (Invesco)
Growth ETFs: ARRK (Ark Innovation, Cathie Wood)
Middle Ground: SPY or VOO (Vanguard overall ETF)
If we take a look at the most recent price action, we can see that from the 2020 lows to 2022 highs, SPLV rallied 80%, VTV rallied 100% while SPY rallied 120%. This goes to show from the different values to overall market growth, the overall market is going to outperform because within there are higher volatility names.
Now if we compare ARKK from the 2020 lows to their highs (Feb 2021, a year before the rest of the market found highs). We saw a 385% rally, WAY more than all of the ETFs above put together. So why not just invest in growth when it outperformed?
There is too much inconsistency in the performance and the rally was led mainly by the Fed money coming into the market. ARKK growth found a top 1 year before the rest of the market found a top. Now down 70% from highs. While SPLV is down 8% from highs, VTV is about 8.5%, and SPY is about 15% off highs.
Take a look at the charts below which compare the lot.
The point here is that not all investments are going to be good in the long run, that is why we look to stick to proven companies, mega caps. The top holdings in value ETFs or the overall market ETF. Even just indexing and passively investing… Means just looking to purchase a handful of ETFs.
Investors can see the overall ETF holdings in whichever ETF they are interested in on the ETF website. Make sure the holdings are the ones they are comfortable with and make sure that the expense ratio is low! Anything under 0.7% is reasonable!
3. Breaking the Fear of Investing in the Stock Market
Investors such as yourself, since you’re reading this article see the market as a big gamble, which can be the case if you enter with that mentality and look for the large winners or the quick gain. This is an investment, this is a long-term hold and understanding value and proven names will grow will put your mind at ease. Slightly at least, because that’s the point of investing, let the money compound for you. This is step one, then you can get more complicated. However, holding the proven names and passive ETF investments have proven to outperform year after year. It is something to consider.
What names do you know? Apple, Microsoft, Google, Coca-Cola, Johnson & Johnson, United Health, Bank of America? Maybe those are good starting points. Read into their business their dividends, their growth, their price to earnings, their earnings reports, etc. Or you can see which are the top 10-15 holdings in the largest ETFs at Vanguard, Invesco, etc.
There are a lot of ways to break the fear of investing in the stock market and the best way I believe is sticking to value and understanding what you’re compounding for! Companies that are established are a great starting point! Happy investing and remember, the compounding growth in the right places is worth the risk!
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The information contained in this post is solely for educational purposes and does not constitute investment advice. The risk of trading in securities markets can be substantial. You should carefully consider if engaging in such activity is suitable for your own financial situation. TRADEPRO AcademyTM is not responsible for any liabilities arising as a result of your market involvement or individual trade activities.
