You can think of investment income—such as dividends or capital gains—in a similar way: If you don’t immediately need income, you have two options… You can save the dividend payout… or, better yet, invest it.
Today, we’ll go over how this method works… and share a few details that can make a big difference in the final outcome.
Let’s start with the most important reason to consider dividend reinvestment: compounding.
Compounding is the process of crediting the interest (or dividends) from an asset back to the same asset.
If you reinvest dividends each time you get them, you put more money into the stock… and create a slightly larger position. The next time the dividend is due, you’ll get a slightly higher payout. Repeat for as long as you don’t need income—or for as long as you are willing to hold the stock—and your position will grow faster and faster, without much effort on your part.
Eventually, the value of your portfolio will accelerate at an astonishing rate…
Let’s look at an example: Say you own 100 shares of a fake company that we’ll call Acme, which is currently trading for $100 per share.
Let’s also say that the stock pays $1 per share in quarterly dividends… or $100 in income on your 100 shares every three months.
But you don’t need this income… so you opt to reinvest these dividends. This means you can buy one additional share.
Now you own 101 shares… which means next quarter, you get $101 in dividends.
If, when the next quarter-end comes around, the stock has declined to $90 per share, reinvesting this new dividend at $90 per share will buy you an additional 1.123 shares… and brings the number of shares you own to 102.123. Your third quarterly dividend will be $102.123… and you can reinvest it again.
And so on.
The more frequently you reinvest dividends, the faster your income (and final returns) will grow.
It’s easy to arrange for dividend reinvestments; most brokers can set it up for you.
Bear in mind, if you continuously reinvest dividends in just a few of your portfolio holdings, there’s a chance they’ll eventually account for a much larger share of your portfolio than you intended.
So just remember to review your portfolio periodically and rebalance as needed.
The bottom line: Reinvesting dividends is one of the easiest ways to grow your wealth long term… All you have to do is sit back and watch your money grow.
For more strategies to grow your wealth—including specific stock picks—tune into Wall Street Unplugged Premium each week.
