How Do Stock Returns and Compounding Work?

Question

I need help understanding returns from stock investments. I would like to benefit from compounding but I am not sure about how to achieve this.

Answer

The returns from stock investments come in two primary ways. They include:

• Capital appreciation: This happens when the value of the share you own increases over time. For example, let’s say you bought a stock for ₦5,000 per share, and after a year, the price rose to ₦8,000 per share. The ₦3,000 difference is your gain from capital appreciation. This is one of the main ways investors make money from stocks, by buying at a lower price and selling at a higher price in the future. However, keep in mind that the value of stocks can also go down, so it’s important to invest in strong companies or industries with growth potential.

• Dividends: Companies pay shareholders a portion of their profits as dividends. When companies make profit, they might decide to share part of that profit with the people who own their shares, that is, the shareholders. For example, if you own 100 shares of a company that pays ₦10 per share as a dividend, you’ll receive ₦1,000 (₦10 × 100).

Note that it's not all companies that pay dividends, which is more common among companies that don’t need to reinvest all their profits for growth. On the other hand, some companies or startups may skip dividends to focus on expansion. Some investors enjoy both forms of returns. For instance, they buy shares of a company, hold onto them as their value grows, and also collect dividends along the way. This is one way to steadily grow wealth over time.

Here’s an explanation on how to benefit from compound interest:

Compound interest can be simply explained as the process where your money earns returns, and those returns start earning returns, too. Over time, this can help your investments grow significantly. To take advantage of this, follow these steps:

• Reinvest dividends: When companies pay dividends, instead of withdrawing the cash, use it to buy more shares of the stock. This increases the number of shares you own, meaning you’ll earn even more dividends in the future. Some platforms like Bamboo and Trove make this easy with automatic dividend reinvestment options.

• Think long-term: Compound growth takes time to work its magic. By holding onto your investments for years, or even decades, you give your money a chance to grow exponentially. The longer you leave your investments untouched, the greater the compounding effect.

• Invest consistently: Even small, regular investments can add up over time. Set aside a portion of your income every month to invest in stocks or ETFs. This strategy, called dollar-cost averaging, helps to smooth out the ups and downs of the market.

An example of compound interest in action is reflected in this instance. Let’s say you invest $500 monthly in a stock portfolio that earns an average return of 10% per year. If you reinvest all your returns, after 10 years, your investment would grow to approximately $103,376. The key to compounding is to remain patient and let time do the work.

Question

What platforms can I use to invest in an ETF?

Answer

Investing in Exchange-Traded Funds (ETFs) is an easy way to grow your money while spreading your risk across various markets. An ETF is a basket of securities that tracks an underlying asset. The underlying asset could be equities or bonds. For instance, the underlying asset for the Vanguard Total Stock Market ETF (VTI)  includes small, mid and large cap US stocks. Different investment platforms in Nigeria make it simple to get started. They include:

• Bamboo: Allows users to invest in popular US ETFs like the S&P 500 ETF (SPY) or Vanguard Total Stock Market ETF (VTI).

• Chaka: Gives users access to ETFs from global markets, making it easier to invest internationally.

• Trove: Offers a wide range of US ETFs, along with stocks and other investment options.

• Risevest: Focuses on dollar-based portfolios, including ETFs, tailored for Nigerians.

To start investing in ETFs on these apps, the following steps should be taken after downloading the investment app of your choice:

Sign up: Open an account on any of these platforms and complete the Know Your Customer (KYC) process.

Fund your wallet: Add money from your bank account, and the platform will help you convert it to dollars for respective dollar investments.

Pick an ETF: Choose an ETF that matches your financial goals, whether it's long-term growth or steady returns.

Invest regularly: Set aside money regularly to take advantage of market ups and downs over time.

Investing in ETFs is simple, and with these tools, you can embark on your journey to growing sustainable wealth today.