Basic Principles Of Investing

Shares of stocks or index ETF should be bought or acquired in quantities of 10’s, 100’s and 1000’s of share. Try to acquire a minimum of 10 shares of each position. There are multiple ways to do this. You could limit the price of each stock or index ETF to $100 and just keep buying and dollar cost averaging until you have 10 shares. You could also microinvest and buy fractional shares. If for example you want to buy Amazon that costs $3K a share, you could buy 0.1 share or 10% of the share price a month until you have ten shares. If you were to continue to dollar cost average in this manner it would take approximately 10 years to accumulate 10 shares or you could buy an index fund and purchase thousands of fractional shares of stocks a year.

So when it comes to investing in individual stocks or index fund ETF’s you have tier 1, tier 2 and tier 3 levels of investing. Tier 1 is 10’s of shares, Tier 2 is 100’s of shares and tier 3 is 1000’s of shares. The major difference between each Tier of investing is the level of compounding.

I wrote an article last year describing why one of the most important things about investing in the stock market is the amount of shares you own. The reason being is that the more shares you own the greater the compounding effect. The two factors that affect compounding are the number of shares held and the amount of time the shares are held. Charlie Munger once said that the first rule of compounding is never interrupt it unnecessarily. The only way to interrupt it is by selling and therefore not holding a position over a long period of time. It doesn’t matter if you sell when your position is up 100% or down 50% it will limit the ability of compounding to work. So are you saying we should never take profits? No I’m not saying that, what I’m saying is that holding a position for at least 5 years to allow compounding to work is more important than taking profits. This principle holds true especially if you are investing in an index fund. This is because the stock market always goes up over time. When I say the stock market I mean the whole market or a good representation of the whole market and not just the popular stocks of the day. In the 1970’s the popular stocks of the day were called the Nifty Fifties and in 2013 the term FANG stocks was coined. Did all the Nifty Fifty stocks make it? No. Will all the FANG stocks make it? Probably not. Therefore all of the popular stocks of the day won’t always go up over time.

When I say stock market I’m referring to a total stock market index fund or S&P 500 fund. The beauty of the index fund is that it sheds all the losing and out of favor stocks and companies for you and continues charging ahead higher and higher with the strong surviving, innovative and disrupting companies. For instance TSLA is now in and Walgreens is out and you don’t have to do a thing in order to benefit from the gains of TSLA. It’s a beautiful concept set in place by Jack Bogle in 1976. From that point on the average investor was able to get a fair slice of the pie from Wall Street and you can bet the banks and brokerages were upset with this change. It’s a privilege to be able to invest in an index fund thanks to Jack Bogle.

We are all too familiar with what I call credit card magic. If you pay the minimum payment every month you will never pay off the balance. Well, at least not until you pay a truck load of interest to the credit card company over 5 or 10 years. Sometimes what we don’t realize is that compound interest is just as powerful working for us as it is working against us. So instead of paying the credit card company a truck load of interest, we can instead get paid a truck load of interest. At the end of the day there are two kinds of people in this world. Those who earn compound interest and those who pay compound interest.

Compounding at a high rate over an investment career is very difficult to do. Which Tier you end up in essentially doesn’t matter. Compounding works the same in all 3. Aiming for tier 3 is great, but compounding depends on two factors. The number of shares and the amount of time the shares are held. If you can’t buy thousands of share then can you hold a position of 10 shares for 20 or 30 years? Doing this will guarantee the benefit of compounding. At the end of the day money is made in the stock market with the holding and not the buying. So if you can’t buy more shares, just hold for 10 to 15 years and you will come out on top every time when investing in a low cost broadly diversified index fund.

Published by The Fire Investor

Financial Independence hobbyist offering practical wealth building advice for all income levels with a focus on achieving early financial independence.

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