Investing can often seem more complicated that it needs to be.
But investors both new and old can find success following some simple and basic rules. The most important one is compound interest. Thanks to this simple piece of maths, returns accelerate over time as your holdings increase in value.
Here's a simple example.
In 1992, shortly after listing on the ASX (September 1991), the Commonwealth Bank of Australia's (ASX: CBA) share price fell to $5.77. 24 years later it's worth $76.50, and is expected to generate earnings per share of more than $5.77 within the next year or two, and pay a dividend of over $4.00. Had you held the shares for 10 years, you might have made 5x your money – but holding on for 24 years means investors have made more than 13x their original capital and have a yield approaching 70%.
Here are another 3 simple strategies every investor should learn, to build a nest egg for a joyful retirement.
Index funds
Instant diversification, low management fees and low brokerage fees are all features if investors want to start investing and buying units in an exchange trade fund that tracks an index, such as the Vanguard Australian Shares Index – V300AEQ ETF UNITS (ASX: VAS). It also pays to remember that Warren Buffett has planned for his wealth when he dies by directing the trustee of his estate to place 90% of it into one index fund that tracks the US S&P 500, with the remaining 10% in short-term government bonds.
Dividend reinvestment
Dividends should be part of any investor's long-term strategy. Not only have dividend shares been shown to outperform non-dividend payers, but the extra income gives you more spending money, or even better, a way to accelerate your returns through a dividend reinvestment plan (DRP). That allows investors to receive new shares instead of cash for their dividends – and without paying brokerage. Over the long-term this strategy can soup up your returns – the year after, you will receive dividends not only on your starting shares but also the ones issued in the DRP and compound each year after that.
Some companies that offer DRPs include the big four banks, Telstra Corporation Ltd (ASX: TLS), Wesfarmers Ltd (ASX: WES) and Woolworths Ltd (ASX: WOW).
Buy and Hold
If you haven't heard about the coffee can investment strategy, it offers a valuable lesson about buying shares and holding for the long term. The world's most successful investors use a buy and hold strategy, including Warren Buffett, for a number of reasons. Holding shares over the long term means less trading activity and lower brokerage costs. It also eliminates panic selling, cuts down on mistakes investors might make and if you hold until retirement, there is no capital gains tax payable because of the tax-free status of retirement income. However, sell shares for a gain within 12 months of buying them and you'll pay tax on the gain at your top marginal tax rate.
For investors holding dividend shares, it also means that your yield over time increases – as per my Commonwealth example above, no wimpy 5% yields here!
Foolish takeaway
The ultimate simple investing strategy would consider combining all three of those elements. It's fairly easy to invest the core of your portfolio in a variety of ETFs, reinvest the dividends and add to your holdings regularly over time.
