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Dividend Reinvestment is a Compounding Accelerator

Dividend Reinvestment Blogpost - iStock-1322479796 (Narrow)

Dividend Reinvestment is a Compounding Accelerator

In last month’s commentary discussing the strengths of dividend growth stocks, we made the case that they should play a key part in a retirement income strategy. Of great importance, we note that dividend reinvestment is a compounding accelerator in this month’s commentary.

Is dividend reinvesting compounding?

The fact that dividend reinvestment is a compounding accelerator should be highly appealing to every investor, not just retirees. Their qualities make them a very good solution for those who are still accumulating assets to fund their retirement. Dividend growers tend to be well managed, exhibit steady revenue growth, have strong competitive advantages, and have less-volatile performance ‒ fine qualities indeed.

By reinvesting your dividends, you can accelerate the power of long-term compounding in your investment and retirement accounts. By methodically plowing dividend income back into these high-quality stocks, investors may meaningfully increase their annual returns and total assets.

A hypothetical illustration reveals the powerfully positive impact that reinvesting your dividends can make. Let’s go back in time to May 31, 1995 and open two investment accounts ‒ Account A and Account B. In each account, we will deposit $7,700 and purchase 800 shares of Colgate Palmolive at $9.63 per share, which offered a 2.13% dividend yield at the time.

In Account A, we’ll take the dividends we earn and put them in our pocket to spend. In Account B, we’ll systematically reinvest our dividend income to buy more shares ‒ using a commission-free dividend reinvestment plan.

Let’s fast-forward to December 31, 2021. What we’ll find is that Account B’s balance dwarfs that of Account A. Account A, in which we pocketed our dividend earnings, grew by an average of 8.55% per year (not bad at all), to end with a balance of $60,572.

Account B however, with its steadily reinvested dividends, grew by 11.79% annually (a little more than 2% better average annual compounding), for a much, much larger final balance of $109,940. That’s $49,368 more dollars, an astounding $81.5% more money from just a bit over 2% higher rate of return over just less than 25 years. And all you had to do to get it, was reinvest your dividends!

This is obviously just one example. But the advantage of reinvesting dividends holds up well for a well-diversified portfolio of high quality dividend growth stocks. This is why the cornerstone of our investing strategy capitalizes on this simple but powerful mathematical fact: Dividend Reinvestment is a Compounding Accelerator. We explore this in our proprietary research paper, Deliberate Dividend-Growth Investing for Rising Income and Capital Growth.

Percentage-wise, gaining a few percentage points by reinvesting dividends may look good, but not necessarily jaw-dropping. But when that difference is compounded over time and translated into dollars, dividend reinvestment starts to look like a spectacular strategy.

Especially in today’s environment of increased stock market volatility and still relatively low fixed-income yields, a dividend reinvesting strategy built with high quality dividend-growth stocks may make a major difference in your ability to accumulate the assets necessary for a comfortable retirement.

While recognizing that dividend reinvestment is a compounding accelerator, building such a strategy involves the ability to research and identify individual stocks and manage them in a properly diversified portfolio. If you would like help implementing a dividend growth strategy in your investment and retirement accounts, we may be able to help. Investment management, is just part of what we do. Contact us for more information.

Source:  Intelligent Capitalworks; Bloomberg

Dividend reinvestment, dollar cost averaging and diversification strategies do not assure a profit or protect against losses in declining markets. Dividend amounts change each year and are not guaranteed.