A friend of mine is likely coming into a windfall. He was a very early employee and investor in a startup that is being acquired.
It’s the kind of result everyone who’s ever been involved in a startup dreams of.
I’m happy for him. He’s worked incredibly hard over the past 10 years and spent a lot of time on the road away from his family.
But he could have done even better.
Let me explain.
When he started, he was given a small percentage of the company. But he also invested his own money in the business in order to hold a larger stake.
He invested $250,000 and will just about double his money.
However, had he simply put that money into the S&P 500, it would now be worth $723,750.
My buddy put a decent amount of his net worth into one new and speculative company. If he’d invested in the S&P, he’d be betting on hundreds of America’s best businesses.
Perhaps he wouldn’t have known to select Nvidia (Nasdaq: NVDA) as a stock to buy 10 years ago. But by owning the S&P 500, he would have had exposure to it as it became one of America’s hottest companies and stocks. He’d also have owned huge winners like Microsoft (Nasdaq: MSFT), Apple (Nasdaq: AAPL), Eli Lilly (NYSE: LLY), Costco (Nasdaq: COST), and many others.
He would’ve experienced the power of compounding dividends as well. Over the last 10 years, dividend income was responsible for 23% of the market’s total return. That’s consistent with the 24% of the S&P 500’s average monthly total return that dividends have accounted for since 1957.
By betting $250,000 on that one company, he missed out on roughly 23% more returns by the simple fact that he wasn’t paid a dividend like he would’ve received from the broad index.
I see investors make similar mistakes all the time as they try to pick the right stocks. Sure, owning top-performing stocks can be lucrative (and I’ll admit that it’s fun owning individual stocks). For most people, however, owning a diversified group of index funds or ETFs is the best way to go.
Markets go up over the long term, and if you own the broad indexes, you’ll participate in those gains. But if your focus is too narrow, you have a good chance of missing out.
Make sure you’re receiving some dividends too. They will substantially boost your return over the long term, and they make bear markets easier to handle when they occur.
If my friend had asked me what I thought before he committed that cash a decade ago, he’d be sitting on about a quarter of a million dollars more – and he would’ve had a lot less stress about whether he was ever going to get his money out.
Investing doesn’t have to be complicated. Own the broad indexes and collect dividends. Over the long term, your returns will be strong and your stress will be lowered.
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