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Often company shareholders are rewarded with a dividend – this is a portion of the company’s profits which the board of directors decides to share with investors when a company has performed well. It is always extremely gratifying for investors to receive a dividend cheque in the post and tempting to use the windfall to treat oneself. The smart investor however, will reinvest the dividend to receive additional shares of stock and benefit in several ways:
Dollar cost averaging is simply investing on a regular basis regardless of what the markets are doing. When prices are low you buy more shares and when prices are high you buy fewer shares. It reduces the risks of trying to time the markets and has been a proven strategy in building up wealth. In this case, every time dividends are paid (usually quarterly or annually) the money is reinvested to purchase more stocks and build your portfolio.
Warren Buffet highlighted the importance of compound growth when investing when he said ‘My wealth has come from a combination of living in America, some lucky genes and compound interest’. Just as interest attracts interest and benefits from compounding so reinvesting your dividends has the same effect – each time you reinvest a dividend payout you acquire more shares but it doesn’t stop there. Next time you receive a dividend payment it will be on not only the original shares but also on the extra ones that you bought and so your portfolio grows exponentially.
This table from an article in the Telegraph shows just how much difference reinvesting your dividends can make.
If you don’t have a regular savings plan set up it can be costly to add small investment amounts to your portfolio, sometimes requiring a minimum investment of thousands, but reinvesting your dividend allows you to potentially add less significant amounts to your investment fund this without facing penalties.
You can arrange for your dividend payment to automatically be reinvested so this really is an easy option to building your portfolio.
In these challenging times we need all the help we can get to achieve our financial goals, which is why it is worth sacrificing the instant gratification of spending your dividend when you can make that money work really hard for you to build your future wealth.
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