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Smart Portfolios - Dividend Reinvestment

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Compounding forms the crux of successful long term investing. It is how an asset, e.g. a share or bond, generates income which is then reinvested in the same income-generating asset, essentially creating earnings from previous earnings. Think of it as the snowball effect in its finest form.

 

Imagine that a grandparent gives both you and your twin sister £1,000 worth of shares in Golden Goose Group Plc for your 25th birthday. This company’s share price has risen steadily at 6% each year, and it pays an annual cash dividend of 4%.

When the first dividend is paid you use the £40 to splash out on a modest trip to a local pizzeria followed by the cinema. Fast forward 40 years and your shares have grown tenfold and are now worth £10,285 as a result of rising 6% each year. Your annual dividend rolls into your bank – a not to be sniffed at £411. Thanks Grandma.

 

However, at an obligatory Christmas gathering you find yourself talking to your sister about how well the Golden Goose investment has been. It transpires that back when Grandma gifted the shares, instead of taking the dividends as cash, your sister opted to have her dividends reinvested. You feel sick to the stomach when she tells you that her shares are now worth £45,259 and her latest dividend was £1,810

 

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And that’s it really. If you multiply a number again and again by a slightly larger percentage, the difference is astonishing. Some investors may need to supplement their income with cash paid out by their investments. But if you’re in a position where you can afford to reinvest those dividends, your wealth over the long run will be substantially greater than if you choose to spend the cash instead.

 

Our Smart Portfolios automatically reinvest dividends whenever they are paid. Some providers charge you for this privilege, we don’t.

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