Reinvesting Dividends Is Invaluable In The Long Term
By reinvesting your dividend payments (instead of cashing them), you buy more shares, which leads to ever larger dividend payments.
These larger payments can then be used to buy ever more shares and so on. In time, even a small shareholding in dividend paying shares can grow into thousands of shares.
Take a look at my chart below to see what happens to a £20,000 investment earning a 7% annual dividend yield that’s reinvested.
Scenario one – you cash in your dividends
After one year, you receive £1,400 in dividends. As long as the dividend isn’t been cut or increased, you will receive every year £1,400, annually. This doesn’t change over time. After ten years you still receive the same £1,400 (all else being equal).
How different is the situation if you decide to re-invest your dividends.
Scenario two – reinvesting your dividends
You don’t cash in the dividends; instead, every year you use the dividends to buy more shares (in this example, for the sake of simplicity at the same share price as the original purchase).
After 5 years thanks to the power of reinvesting dividends your investment is generating £1,964 in annual income. In ten years time it would be generating £2,754, almost double when compared to the amount if you would have been cashing in your dividends each and every year.
Scenario three – reinvesting your dividends with 5% dividend growth
After 10 years, thanks to the power of reinvesting dividends and 5% annual dividend growth, your investment is now generating £5,299 in annual income -that’s 278.5% more income when compared to an investor who had decided against reinvesting dividends and instead cashed them every year.
In addition, your £5,299 in annual dividend is now generating an effective yield of 26.5% based on your initial £20,000 investment 10 years earlier. Just grab your calculator; type 5299 divide by 20000 and multiply the answer by 100 and you get 26.5 per cent return.
your dividends puts your dividend growth into overdrive!
And it’s exactly these types of high quality companies with increasing dividend payments that I would be considering for the Dividend Income Portfolio.
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