There is a timeless investment strategy that predates most publicly traded companies today. The strategy takes very little time and effort and can greatly accelerate the composition of your portfolio. There are no costs. In addition, you can set the strategy to automatic in your trading account for consistency. It almost sounds too good to be true.
Called dividend reinvestment, the strategy is employed by novice investors and some of Wall Street’s most experienced professionals, such as Warren Buffett. Dividends are rewards (usually cash) that a company or fund gives to its shareholders per share. Companies with good profits and excess income can reinvest the money in operations, pay off debt, or pay a dividend to reward shareholders.
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High inflation, slowing GDP growth, the war between Russia and Ukraine and challenges in the supply chain are putting pressure on the stock market. In short, it reminds us of the power of using a diversified portfolio that is not too concentrated in a single sector. Some investors prefer to “go defensive” during such times, or convert their portfolio to a more conservative stance. One way to achieve this: Dividend stocks, which are reliable, and their dividend yields represent a steady stream of income even when the markets are turning south.
How it works: With your dividends, you buy more stock, which increases your dividend yield next time, which allows you to buy even more stock, and so on. For example, say you own 1,000 shares of a stock at $100 per share, for a total investment of $100,000. Assuming a 3% dividend yield, that’s $3,000 in dividends that you can reinvest right back into your investment.
How to reinvest dividends?
Investors can sign up for automatic dividend reinvestment programs through their brokerage account, usually in the account settings menu. You have the option to automatically subscribe all current and future stocks and funds or select individual stocks and funds to automate.
Some investors put in dividends as cash to pay off bills or invest in other stocks. But automatic reinvestment can pay off, especially over a longer time horizon of several years (or longer). Dividend reinvestment is cheap and automatic, with no fees. It’s simple, flexible – you can acquire fractional shares through dividend reinvestment – and consistent – you can buy shares regularly, for example every quarter.
Dividends don’t have to be just for retirees
You’ve probably heard stories of retirees living off dividend stocks. It is a dream for many people to easily cover their retirement costs thanks to their quarterly dividend payments. The strategy helps conserve capital and generates a growing income stream regardless of market conditions. For those retirees, it may make the most sense not to reinvest your dividends so you have that money on hand when you need it. Plus, reinvesting dividends may not be a good strategy for people who need those dividends to cover bills, pay off debt, or balance their portfolio.
But for many investors, regardless of your age or investment experience, automating your dividend reinvestments is an important mechanism for increasing returns. DRIP (Dividend Re-Investment Programs) allows investors to profit hands-off from dividends.
It’s also a perfect use of dollar cost averaging, a strategy where an investor splits the total amount to invest among periodic purchases of a target asset class to reduce the impact of volatility. Purchases take place regardless of the price of the asset and at regular intervals.
Investors can boost growth by establishing mechanisms to reinvest dividends. Just as staying invested during the inevitable ups and downs of the market can help you avoid missing out on the best days, automatic dividend reinvestment is another easy way to grow your wealth.
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