By Robert Ross
If it seems too good to be true, it usually is. But when I say you can juice your investment returns with the click of a button, it’s the plain truth.
I’m talking about reinvesting your dividends.
It may seem like a minor thing. But if you’re not doing it, you’re leaving a lot of money on the table.
In fact, investors who reinvest their dividends can outright double their investment gains.
Let me show you how…
Reinvesting Can Make a Big Difference
Say you own 100 shares of McDonald’s Corp. (MCD).
Every quarter, McDonald’s pays a dividend of $2.00 per share. That translates to $200 in income from your 100 shares.
When this happens, you have two options:
- Pocket $200 in cash or
- Reinvest $200 directly into McDonald’s shares.
Hint: Choose option two.
Now, McDonald’s trades for around $200/share. So instead of pocketing $200 in cash, you get one extra share.
Then you make the same smart choice the next quarter… and the next. True, it’s only one extra share each quarter. But over time, it makes a huge difference.
That’s because reinvesting your dividends takes advantage of compound interest.
Compound interest is the interest on your initial investment, plus interest on all interest earned. This means your interest—or in this case, your reinvested dividends—earns interest, too.
In other words, those reinvested dividends make your whole investment grow much, much faster.
Reinvesting Your Dividends Can Double Your Returns
Let’s walk through an example.
Say you bought $20,000 worth of McDonald’s stock in 1998. You pocketed the dividends from half of your investment. And you reinvested the dividends from the other half.
By 2019, the first account had grown from $10,000 to $66,598. That’s a total growth of 565%, or 9.9% annually. Not too shabby.
Meanwhile, the second account—the one with the reinvested dividends—had grown from $10,000 to $120,073. That’s a total growth of 1,100%, or 13.0% annually.
Now that’s remarkable.
Your money grew almost twice as much. And the only thing you did differently was reinvest your dividends instead of taking the cash.
Reinvesting your dividends does two things:
- You get more stock, which can grow in value over the long run.
- For every additional share you own, you get an additional quarterly dividend.
Over time, this leads to a lot more money.
This Isn’t Limited to McDonald’s or US Stocks
Let’s look at a few other examples.
Say, 50 years ago, you invested $1,000 in the S&P 500. So did your neighbor. We’ll call him “Jim.”
Jim didn’t reinvest his dividends. But he still earned an annual return of 2.3%.
But you were smarter. You reinvested your dividends every quarter. So you earned an annual return of 5.3%. That’s more than twice as much as Jim earned.
This strategy is universally effective. You’ll make a lot more by reinvesting your dividends in any market.
Just look at the difference in returns from the world’s eight largest stock markets since 1993:
Source: Schroders
As you can see, reinvesting dividends led to much higher returns across the board.
On average, people who invested in one of the eight major stock markets—without reinvesting their dividends—earned 4.3% annually.
Meanwhile, those who reinvested their dividends earned 7.1% annually.
Shielding Your Portfolio from the Coming Recession
You can’t fight the math.
If you’re not reinvesting your dividends, you’d better have a solid reason why. Otherwise it’s like dropping $100 bills on the sidewalk. Just waste.
I think dividend reinvestment is a good idea for all investors—and at every point in the market cycle. That’s especially true when you own safe and stable stocks.
These stocks tend to do well no matter what’s happening in the economy or the markets. So when the next recession hits—something I expect in the not-so-distant future—and the broader market suffers, you will still own quality businesses that will make it through.
Plus, if you’re reinvesting your dividends, you’re getting more of a good thing, possibly at better prices. And you’re taking advantage of the magic of compound interest.