I hope this isn’t too basic a question, but I have some doubts about my understanding of compound interest in my investment strategy with ETFs. Let’s consider investing solely in the VT ETF with a purchase price of $100 USD for simplicity.
If I start the year by investing $10,000 USD (thus acquiring 100 shares) and the price increases to $110 USD by the end of the year, my understanding is that I would have earned $1,000 USD. If, in the following year, the price returns to $100 USD, my investment would revert to the original $10,000 USD, right? So, it seems the only way to benefit from compound interest is to reinvest dividends earned by buying more shares “for free” with the dividend amount directly depending on the fund’s performance.
Is this correct, or is there a flaw in my reasoning?
The compounding starts on the company level. In average the companies make money and reinvest a share of their profit to expand their business. Reinvesting the money they distribute creates a new level of compounding
You’re not buying shares for free with the dividends. Imagine a stack of 100 $1 coins. If you’re buying more shares of the same ETF with the dividends then you’re basically being given a few of these $1 coins and then putting them back on the stack yourself. The stack will have the same height if the ETF was accumulating.
Take VWRL and VWCE and put their graphs side by side. VWRL is older, but if you get the graph within the same time frame you’ll see that VWCE has done ~45% growth (since 2019 or so - may be off, I looked at it some months ago) and VWRL has done the exact same number WITH dividends reinvested and ~34% WITHOUT. This is a simulation not accounting for tax treatment, but I understand we’re taxed on estimated dividends with accumulating funds too, so there’s likely not much difference. The difference is US ETFs which by law have to distribute dividends, the difference and benefit for US-domiciled ETFs with US-only securities is part or all of the withholding tax levied by the US can be reclaimed.
Dividend growth investing…I haven’t made up my mind while thinking and researching about it, but not buying anything, for at least a year now. Looks good on paper but the simulations don’t agree. It’s more of a psychological benefit and accidental/incidental capturing of some quality and value factors, which explain why it can and has done better in recent years.
Reinvesting dividends is a part of compounding, +/-1-2%. What I and others do is look at dividends as a way to fund other stuff. I personally use dividends from VWRL to buy BRK.B shares. Slowly, but will be faster in the future. Still these aren’t free, it’s just taking money off one stack and putting it in another stack rather than back where they came from.
To nitpick: Don’t call it “earned”. Earnings imply that you realised them and that they may be taxable. You’d rather have a (temporary) capital gain of $1000
On BRK.B: I get the tax benefit of not having dividends. But the companies owned by BRK.B will still pay dividends, and BRK will have to pay US taxes on that, resulting in less returns for BRK.B stocks.
Kind of a zero sum game, no? (apart from significant concentration risk in BRK, of course)
It’s more of a long-term plan, BRK.B to be my forever stocks to be passed on to my children. Of course, Buffett hasn’t “got it” as much as he did in the past, he said as much himself, and nobody is immortal so he’ll pass away eventually. I like to think BRK.B as a hedge of S&P500-like returns (it hasn’t CRUSHED the S&P500 for a while now) with lower correlation. Yes, yes, Apple is a sizeable part of the BRK portfolio
Personally I still think the post-Buffett management will do good things, possibly even extraordinary things.
Not to curb your enthusiasm, but see this financial times article:
“Warren Buffett’s deputies are trailing both their mentor and the market, according to a Financial Times analysis that examined the performance of the two men set to take over Berkshire Hathaway’s $354bn stock portfolio.”
Good article, cheers. Let’s see what happens. It’s been hard to outperform the S&P500 when so much of its value is in a handful of companies, BRK owning only one of them. I am am optimist - have to be - given I hold BRK shares!
The times, information availability and opportunities are slightly different now than they used to be 30-40 years ago; I would not expect same moves and performance to be repeatable, even by a “young Buffett” himself.
It‘s mainly a capacity problem. BRK is just too big. They may find a small new business they can buy for say 2 billion. What does that matter for BRK‘s total value even if that new business does really well? They would need to find 50, 2 billion businesses to have a material impact and that‘s really hard/impossible.
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