The Magic Of Compounding Via Dividend Investing

I am often able to add new shares of stock to my investment portfolio without placing one dime of my own money. I own a number of different stocks that pay me dividends. Instead of receiving a cash payout from all of these companies, I simply opt for dividend reinvestment which adds more shares to my initial investment position. This method has worked well for me and can do the same for you as well. In order to give you a better understanding of how dividends work, let’s take a look at the magic of compounding through dividend investing.

Why People Love Dividend Investing

Dividends are a great way to increase wealth for any investor that has ever taken the time to buy stocks. They can be used for supplemental income  to generate some extra cash. One of the overlooked areas when it comes to dividend investing is how they can be used to increase investment positions through dividend reinvestment.

Dividends that are paid out by companies on a quarterly basis can be used to buy more shares and save you on trading fees. Most brokers that offer dividend reinvestment charge much lower rates for dividend reinvestment than buying stock outright. You could wind up paying $9.99 to buy shares of stock whereas you can reinvest dividends for a 30 or 40 cent charge at many brokers.

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Here is an example of how a dividend plan works.

Let’s say you bought 200 shares of AT&T (T) at its current price of $30 per share. You would pay a total of $6,000 for your shares. AT&T has an annual dividend of $1.72. If you still owned the stock on July 6th when the company declares a dividend, you would be entitled to receive 43 cents for every share that you owned. That is a total of $86. If the stock was still priced at $30, you would receive approximately 2.86 additional shares. You would now own 202.86 shares of AT&T.

AT&T pays another dividend on October 6th of 43 cents per share. You would receive a total dividend of $87.23.  If you reinvest those shares, you would receive 2.9 shares.  Assuming that the stock price remains stable, your total shares owned would increase to 205.76.

You would be entitled to your 3rd dividend payment on January 6th. Your dividend payment of $88.47 would add 2.95 additional shares to your portfolio. Your total shares would grow to 208.71.

AT&T would pay you another dividend payment on April 6th of $89.74. You would receive an additional 2.99 shares at the $30 price.  At the end of your first year of owning the stock, you would own 211.70 shares of AT&T.

You have picked up 11.7 shares of AT&T with a market value of $30. Your total gain would have come in at $351. That is a 5.8% return on your money.

The aforementioned example shows why investors love dividend stocks. It is a great way to increase the total number of shares that you own and increase your return on investment. It is a win-win situation. If the stock had decreased in price during the year, you would have been able to purchase even more shares at a lower price. If the stock had increased during the year, you would have purchased fewer shares but your portfolio would be more valuable because of the capital appreciation.

Comments

  1. Reinvesting your dividends is a great idea! There are no additional transaction fees, and you allow your money to compound within that particular stock.

  2. Thanks for breaking that down and explaining it in simple terms. Nice to see that dividend investing can yield such a high return! Increasing your income and expanding your portfolio at the same time is not bad at all, and I really like the idea of using dividends to buy additional stock instead of forking in more of my own money. I’ve been looking for some better investment opportunities without taking too much of a risk and I think this might be a great option.

  3. avatar Dave Gresko says:

    Compounding dividends is exactly that – magic! Forget the get rich quick high-flying tech stocks. You need to stick with stocks that are predictable (read boring) and pay you consistantly for your ownership. Its key to reinvest the dividents or it throws your compounding % off. Once you buy into dividend investing your next task will be to make sure you live long enough to “get rich!”

  4. avatar WealthSavant says:

    Once you buy into divendend investing, your next task is just to ensure you live long enough to reap the benefits!

  5. I agree with LAMF, you should reinvest your dividends unless you need the cash flow.

  6. We been DRIPing for years (Dividend Reinvestment Program). Once in awhile we would flip them over to cash dividends if we needed the money – and it is like a spigot spewing money out at you! Then we would turn them back to re-invest and keep accumulating.

  7. The magic of compounding is a wonderful thing. Just one of many reasons I take advantage of dividend investing. Thanks for the article.

    I don’t DRIP, however. I take the dividends I receive and let them accumulate for a month or so…and then with the captial infusion I make into my brokerage account once a month I purchase shares in what I think is the best valued business at the time. I don’t DRIP simply because in a DRIP plan you are repurchasing shares in the business that may not be the best deal at the time. However, a DRIP plan is great for auto-piloting your portfolio.

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