Monday, February 24, 2014

How You Get Money From Investing

This stuff is also applicable to mutual funds and index funds!
Read this if: 

1) You have investments (ex. stocks, mutual funds) but you don’t know how they get you more money. 
2) You want to read my blog post, just for the heck of it. 
3) You know a bit about investing already. (If not, read this.)

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We all know that investing can lead to wealth, but how does it actually happen? What is about investing that actually increases how much money you personally have? Allow me to enlighten you! 

Example

Here's the story: 

I own Joan's Fun Company (JFC for short). You decide to buy stocks in JFC (five shares at $10 each so you spend a total of $50). I want to thank you for investing in my stock, so I give out dividends (so you get $1 per share just for buying). My company does really well, so shares rise to being $152 each (because who doesn't want fun)! You decide this is a great time to sell, and sell all your shares, to make a profit of $715. 

Here's how you calculate how much you earned: 

760    from selling
+  5    $1/share for dividends
——
765
- 50    how much you paid at the beginning 
——
715    net gain

So what are dividends?

Dividends are given to you by the companies that you invest in. Why they do it, and how, varies from company to company. 

What are capital gains?

Capital gains are a result of economic stuff that we don’t really need to go into. If a lot of people want to buy a stock, but not many people are selling, then the price of the stock goes up. That means when you sell it, you get more money than what you originally paid. 

Bottom Line

Obviously the example is a wee bit exaggerated and a wee bit simplified, but I think it’s good to understand where your money is coming from. (Keep in mind that we didn't take into account fees, or how often dividends are paid, etc.) Knowing the difference between dividends and capital gains is also important for several other areas of personal finance like taxes and "reinvestment strategies" (but we'll get into that later). 

If you want to read about a much more realistic example, here is a great article that explains the difference between dividends and capital gains.

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As always, contact me with questions or suggestions! 


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Photo Credit: LendingMemo via photopin cc

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