Stocks and Shares Compounding

Rich48

Hi all, looking for some advice about investing in stocks and share ISA.

Videos on Youtube etc tell us about the benefits of compounding and how this can increase the value of investments over time.

1. Am I right in saying Index funds such as S&P 500 don't automatically re-invest any increase in share value?
2. If your shares rise in value and you reinvest in new shares, is this what they mean by the power of compounding?

Thanks in advance

RacingDriver

It depends if the fund is an income fund (that pays out the income) or an accumulation fund (which re-invests the income).

EthicsGradient

"Funds", by which I guess you mean OIECs, typically come in 'income' and 'accumulation' versions. The latter automatically reinvest dividend income they receive (after they've taken their expenses). This dividend income is the only thing available as "increase in share value" to be re-invested, or not, rather than the rise in a share's price.

"They" may mean "re-investment of dividend income" if they talk about "compounding", because it's similar, but strictly, "compounding" refers to interest-bearing accounts.

If it's ETFs, then the versions may be known as "distributing" and "capitalizing" (sometimes using the abbreviations D and C).

thebikemechanic

Hey Rich, there are lots of resources to help you but (if appropriate as per forum rules?) may I recommend something like the Meaningful Money handbook - which is a guide from podcaster and financial planner Pete Matthew. He's UK based and it really helped me. 

To directly answer your questions though: 

1. There are two ways that equity investments broadly make (or lose) money. Increase in share value, and through dividend payments (there are other things like loyalty bonuses, special dividends, etc). Your question mentions increase in share value, and this happens generally daily with the value of your given number of 'units' changing in accordance to their value. Therefore, there is nothing to 're-invest' here. However, dividend payments which are made (monthly, quarterly, bi-annually, annually), can be 're-invested'. When you buy units in the fund, you can usually select 'income' variants where the dividend payments are held as cash on account and not 're-invested', and 'accumulation' funds where these payments are automatically re-invested in the fund for you. 

2. Yes, kind of. Again, we are dealing with share price, and dividends. In terms of the value of the fund, the thing to remember is that the market works in percentages, so the more units you own and the more they are worth, the more every 1% going up gets you. In terms of dividends, again the greater the size of the investment, the bigger the dividend payment, and therefore the more you add to the value of your account, which is then bigger by the time the next dividend payment happens, so that payment is even bigger, and on and on and on. The effect of this is tiny at first, but grows massively after many years. I recommend googling a compound interest calculator and plugging in some numbers and seeing the effect. 

Hope that made sense. 

Rich48

Hi all, thank you for the information - much appreciated:)

Kaizen917

I always found this topic interesting (within the confines of investing that is). For instance, my acc funds supposedly grow in value with dividents but number of shares remains the same unless I buy more with extra funds. In that case, compounding feels a bit counter-intuitive since its not similar, for example, to how a person would earn more interest if the cash in their savings account grows with every next interest gain.

mooneysaver

Most shares have an interest rate of 5% so if you invested £100 after a year you would have £105. After two years you would have £113.75 (105% of £105) this is what is meant by compounding.

Of course most stocks have variable interest rates but for any stocks listed on the FTSE the CFO and chair need to provide 30 days written notice before chaging the interest rate. If you're holding your shares in an investment trust the manager will normally monitor these notices.

Gary1984

Say you bought 100 units in a fund for £1 each. Over a year the underlying assets within the fund pay dividends worth 5p per unit.

As you're in an Acc fun you would still have 100 shares but each is now worth £1.05. So your shares have £105 value.

An Inc fund would pay out the dividends on the underlying assets to you. Each unit is still worth £1 and you still have 100 units so a total unit holding of £100. However you also have £5 in cash from the dividends so £105 total.

You could then reinvest the £5 cash in the fund and buy five more shares. You'd then have 105 shares total worth £1 each so £105 again.

So three different ways to cut things up, but the same end result in each (ignoring trading expenses, taxes etc).

AlanP_2

mooneysaver said:

Most shares have an interest rate of 5% so if you invested £100 after a year you would have £105. After two years you would have £113.75 (105% of £105) this is what is meant by compounding.

Of course most stocks have variable interest rates but for any stocks listed on the FTSE the CFO and chair need to provide 30 days written notice before chaging the interest rate. If you're holding your shares in an investment trust the manager will normally monitor these notices.

Shares. as in equities, do not have an interest rate of any kind.

The company may declare a dividend payment, which may be expressed as a %'age against the current share price but no "interest".

EthicsGradient

mooneysaver said:

Most shares have an interest rate of 5% so if you invested £100 after a year you would have £105. After two years you would have £113.75 (105% of £105) this is what is meant by compounding.

Of course most stocks have variable interest rates but for any stocks listed on the FTSE the CFO and chair need to provide 30 days written notice before chaging the interest rate. If you're holding your shares in an investment trust the manager will normally monitor these notices.

"Most shares have an interest rate of 5%" - wrong.
"After two years you would have £113.75 (105% of £105)" - wrong (105% of £105=£110.25)
"most stocks have variable interest rates" - wrong. If you mean corporate bonds, most have rates fixed when issued. 
"for any stocks listed on the FTSE the CFO and chair need to provide 30 days written notice before chaging the interest rate." What the hell?

Why do you bother posting this nonsense? You made stuff up about what a GIA is, and a "mortgage trust", and the nature of Scottish Mortgage, and after you were corrected, you repeated your rubbish on another thread.

Malthusian

EthicsGradient said:

Why do you bother posting this nonsense? 

As the OP's username implies, he is only here to promote the SafeMoon Ponzi scam and has no real interest in savings or investments.