It’s a common misconception that equity investing is akin to “putting everything on black” in the casino.
Though investments can fall in value as well as rise, there is an important difference between gambling and investing.
When you invest, you are buying a share in a real-world company. The companies that are listed on the stock market produce and sell goods or services to real people, and their profits help you to generate a return on your investment in them.
When you invest in a company or companies on the stock market, you hope that the value of those shares will rise so that, in the future, you could sell them for a profit.
Additionally, you could receive a payout from the company’s profits, known as a “dividend”.
Dividends are a helpful way to understand how the company that you have invested in is performing financially. Depending on how you use them, they could help you to grow your wealth more quickly. Read on to learn more about how dividends could help you to achieve your long-term goals.
As an investor, you can choose to either spend or reinvest your dividends
If you receive dividends from your investments, you’ll need to decide how you’d like to use them.
One option is to withdraw your dividends as cash. Dividends used in this way could provide a useful way to supplement your income and offer a more immediate pay-off from the sensible decisions you’ve made with your portfolio.
A second option is to reinvest your dividends, buying further shares in the same company or fund. In doing so, you can increase the proportion of the company that you own.
The first option may be attractive because it offers an immediate cash reward. The second option could be worth considering because reinvesting your dividends can help to increase the value of your portfolio without needing to pay in additional cash from your own pocket.
Reinvesting dividends could mean that you benefit from compounding over time
If you choose to reinvest your dividends, this could have a significant impact on your long-term wealth accumulation. This is because your portfolio won’t just be generating returns on your initial investment, it will also generate returns on your returns. This is known as “compounding”, or “compound returns”.
The example below from Charles Schwab demonstrates how this could affect a hypothetical $100,000 investment in a fund that tracks the S&P 500 in 1990:
- If you had taken all your dividends as cash, by the end of 2022 your investment would be worth $1.1 million.
- If you had reinvested all dividends, by the end of 2022 your investment would have been worth $2.1 million.
As you can see, reinvesting dividends can be a powerful way to grow your investment portfolio over the long term.
Interestingly, media headlines about stock market returns don’t usually account for reinvesting dividends. So, if you were invested in a fund that is reported on and you had reinvested your dividends, your returns would likely have been higher than the reports suggest.
Your financial planner can help you to make sensible decisions about your investment portfolio as you work towards your long-term goals
Though choosing what to invest in is often seen as a crucial part of investing success, the decisions you make when managing your wealth are arguably even more important. As you’ve read above, making sensible decisions could give your money more opportunities to grow.
Reinvesting your dividends could be a helpful way to make progress towards your long-term goals. Some providers allow you to set up automatic reinvestment so that you don’t need to think about it each month.
Your planner can provide further guidance on the most sensible steps to take when managing your investments and growing your wealth based on your personal circumstances and goals.
