Remember when we talked about the two ways to make money as an investor?
Come on! It wasn’t that long ago, was it? The two ways are:
(1) The value of the investment goes up
So if you buy a house for $100,000 and it goes up to $125,000, that $25,000 is growth, or appreciation. That’s one way to make money. The second way is if the investment provides you with income. Take that house you bought for $100,000. Let’s say it didn’t go up at all and stayed stuck at $100,000. Could you still make money? You bet! If you had a renter paying you $2,000 a month, you’d make $24,000 a year in rental income.
So let’s talk a bit more about that second way to make money – through income.
Income from investments is like Lady Gaga – it can take many different forms. Income can be interest, dividends, rental income, or capital gain distributions. It’s not so important to get hung up on what each of these is at this point. The lesson is that some investments pay income.
The question is what should you do with that income?
If you had that rental property and were getting $2,000 a month, what could you do with it? Well, you could take it down to the local bingo game each month. You could have a killer party with all your friends each month. You could lease a beautiful Rolls Royce. What do all of these have in common? Besides being a lot of fun, they are all examples of you using the rental income. You’re spending it.
What’s another option for the $2,000 a month of income? Well, what if you were to take that money and invest in more rental properties? Hmm. Now that could be interesting.
And this is your choice as an investor. When you buy a mutual fund or stock, you are often given a choice: do you want to reinvest dividends, interest, or capital gain distributions back into the investment, or do you want to just leave these distributions in cash?
When you reinvest the income back into the investment, you are taking advantage of compound investing.
This is a powerful multiplier. This is like the martial art of Aikido, where you use your opponent’s energy against them. In this case, you are using your investment’s income to add more to your investment.
It can mean the difference of thousands of dollars to you, the investor.
Of course, if you are retired and need the cash to live on, that’s one thing, but if you don’t need the cash, you can use your investments to buy more investments.
I like reinvesting income and dividends. Unless you have a really good reason otherwise, say yes to reinvesting!
And if that wasn’t convincing enough, in the next lesson, you’ll learn why re-investing is so powerful and a popular quote from Einstein that Einstein never actually said. Oh, the suspense is killing me!
The proceeding blog post is an excerpt from Get Money Smart: Simple Lessons to Kickstart Your Financial Confidence & Grow Your Wealth, available now on Amazon.
About the Independent Financial Advisor
Robert Pagliarini, PhD, CFP®, EA has helped clients across the United States manage, grow, and preserve their wealth for the past 25 years. His goal is to provide comprehensive financial, investment, and tax advice in a way that was honest and ethical. In addition, he is a CFP® Board Ambassador, one of only 50 in the country, and a real fiduciary. In his spare time, he writes personal finance books, finance articles for Forbes and develops email and video financial courses to help educate others. With decades of experience as a financial advisor, the media often calls on him for his expertise. Contact Robert today to learn more about his financial planning services.