Dear DTA,
I have never bought stocks before. I’m wondering, if I do invest in stock, is my money lost if the stock goes down in value? I’m also wondering if I have to reinvest my profit or income?
-Randy A.
Hi, Randy. Thanks for writing in to us. We take our readers’ goals and questions seriously, which is why we take the time to respond to questions/emails directly like this.
First, I just want to say that it’s great that you’re taking the time to investigate and research investing.
Long-term investing is wonderful. It can literally change your life (as it has mine).
But you shouldn’t just jump in without knowing what you’re doing.
That’s a recipe for disaster.
I wish I could answer your first question plainly and succinctly, but it’s not quite that straightforward.
That said, if you buy a stock at, say, $80 and sell at, say, $70, you will lose that $10 per share.
That’s money gone and lost.
But this is only if you sell.
And nobody is forcing you to sell for a loss.
While it’s sometimes necessary to just move on from an investment that has gone wrong (for any variety of reasons), a decline in a stock’s price is perhaps even more likely to be an opportunity to buy more, not to sell out and lose money.
This is called averaging down.
If you do your research on a company and it’s otherwise more or less performing as expected, a cheaper price on the stock (which would likely infer a cheaper valuation) should be something to be celebrated.
In fact, the benefits can be incredibly tangible and fairly immediate.
Now, I’m a dividend growth investor.
I buy shares in high-quality businesses that have lengthy track records of paying increasing dividends to their shareholders.
You can find more than 800 dividend growth stocks by checking out David Fish’s Dividend Champions, Contenders, and Challengers list, which is an invaluable compilation of all US-listed stocks that have paid increasing dividends for at least the last five consecutive years.
I buy shares in these great businesses. I buy these shares at attractive prices (relative to intrinsic value). And I aim to hold for the long haul (assuming the investment thesis stays roughly intact).
It’s a strategy I used to go from broke in 2010 to financially free in 2016, building a real-life six-figure dividend growth stock portfolio in the process.
It’s a fantastic investment strategy, because it generally involves buying blue-chip stocks with business models that are very easy to understand.
Moreover, the growing dividend income these stocks pay can eventually pay real-life bills, rendering one financially independent.
For instance, PepsiCo, Inc. (PEP) is a well-known and very popular dividend growth stock, with a track record of 45 consecutive years of paying increasing dividends to shareholders.
They sell non-alcoholic beverages and food products to billions of people all over the world.
It’s a business model that’s fairly simple to understand.
The stock yields 2.76%, which beats out most other non-stock options in this environment.
And due to multiple competitive advantages (economies of scale, pricing power, distribution, etc.), they’ve been able to fend off competition for decades. All while increasing profit and their dividend in the process.
The stock is priced at ~$116 right now.
Let’s say you decide to buy the stock right here and now.
If it drops to $110, does that mean you have to (or even should) sell it?
Absolutely not.
If the company continues to pump out beverages and food products like you anticipate, buying more stock for an even cheaper price/valuation should be something to look forward to.
When you’re able to add to an existing position at a cheaper price, that’s averaging down.
And it means you have an even larger stake in a great business, with an overall cost basis that’s lower than it was before averaging down.
That means more stock for a lower price.
That also means more income, as more shares buys more dividends.
All of that likely puts you that much closer to your long-term financial goals.
I’ve personally averaged down many times over the years, almost always looking forward to buying more stock at a lower price. It simply means more shares for the same amount of money; that’s also more passive income for the same amount of money.
Your second question relates back to this.
Until you need your passive investment income to live off of (i.e., to pay bills), you should be reinvesting that income, buying more shares, which in turn adds to your investment income, which then buys even more shares.
Reinvesting dividend income allows a dividend growth stock portfolio to snowball, compounding faster and faster as the passive income grows off of the back of dividend raises, added fresh capital, and dividend reinvestment.
It’s a system that’s practically foolproof.
And it’s tangible – you see that passive dividend income just continue to grow, which eventually becomes a sum that can positively change your world.
You could then be in a situation where you don’t have to reinvest that dividend income any more, instead deciding to “flip the switch” to paying your real-life bills with that real-life passive dividend income.
Dividend income spends just like paycheck income. In fact, it probably spends even better, because it’s so much sweeter when the money comes in without any ongoing input on your part.
But before all of this can happen, high-quality dividend growth stocks need to be purchased at appealing valuations. And these shares then need to be held for the long haul, whereby the dividends are reinvested.
Toward that end, I’d definitely recommend checking out Dave Van Knapp’s series of lessons on dividend growth investing.
This series explains exactly how dividend growth investing works, why it’s such a great long-term investment strategy, and how to successfully implement it.
And then once you’re ready to actually put your capital to work, I personally write a series that highlights an undervalued dividend growth stock every Sunday.
You obviously have an interest in bettering your future self through investing, Randy.
But the key is to take action.
It’s easy to talk about change.
But change requires action.
You have some fantastic tools at your disposal.
So it’s up to you to get started right away.
I wish you luck and success.
Jason Fieber
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Disclaimer: Jason Fieber is not a licensed financial advisor, tax professional, or stock broker. Please consult with a licensed investment professional before investing any of your money. If your money is not FDIC insured, it may decline in value. To protect the privacy of our readers, any names published in this article are under aliases. In addition, text may be edited, omitted or paraphrased for grammar or length.