Want To Become A Millionaire? How Reinvesting Your Dividends Can Help Get You There

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Dividend investing is often touted by investors who appreciate the steady and growing income that dividends can provide. But there’s an aspect of dividends that sometimes gets overlooked. 

“Investing is an activity in which consumption today is foregone in an attempt to allow greater consumption at a later date,” legendary investor Warren Buffett once wrote.

While using dividends as a source of income can be useful, foregoing their use today and instead reinvesting them can boost your investment results significantly over time.

If you’re not sure if reinvesting dividends is the right strategy for you, it may be helpful to work with a financial advisor. Bankrate’s financial advisor matching tool can help you find an advisor in your area. 

Here’s how reinvesting your dividends can help increase your wealth and put you on the path to becoming a millionaire.

Dividend reinvesting: How it works

If you’re invested in stocks that pay dividends or in funds that hold stocks that pay dividends, you’ll regularly receive dividend payments. These payments are a way for companies to share their profits with shareholders, and you’ll have the option of using the cash received however you see fit or reinvesting the dividend into more shares of the stock or fund. 

Reinvesting your dividends can have a significant impact over time. Since 1960, 85 percent of the S&P 500’s cumulative total return can be attributed to reinvested dividends, according to a study by Hartford Funds. 

If you elect to reinvest your dividends, you’ll be consistently buying more shares of the stock or fund over time. Dividend reinvesting is actually a form of dollar-cost averaging, which has proven to be a successful approach for many investors over the years. The idea is that you’re consistently investing over time, rather than trying to jump in and out of the market when times are good or bad.

Example of dividend reinvesting

Let’s take a look at an example of how reinvesting dividends can boost your future wealth. 

Consider an investor who owns 500 shares of a stock that’s priced at $100, for a total value of $50,000. Let’s make the following assumptions about the stock and its dividends over the next 30 years:

• The stock price will grow at 10 percent per year.
• The stock’s current dividend of $3.00 per share will grow at 5 percent per year.

Here’s how an investor would have fared over 30 years if they had taken the dividends as cash compared to reinvesting them. 

You can see from the graph that reinvesting the dividends results in a higher ending value thanks to the compounding effect of using your dividends to purchase additional shares. The additional shares result in higher dividends, which result in more shares and so on. 

To be sure, this example is a simplified one, and it’s highly unlikely you’ll find a stock or fund that rises in this linear fashion, but the concept still stands. Here are some of the best S&P 500 stocks for dividend growth.

If you’re interested in reinvesting your dividends, most brokers make it simple to execute. If you’re placing a new trade, you’ll likely see a box that you can check to have your dividends reinvested. Existing positions can also be setup for dividend reinvestment.

When it makes sense to reinvest dividends — and when it doesn’t

When it makes sense

If you’re saving for a long-term goal such as retirement, you’ll likely want to reinvest your dividends. The money has more time to compound and if you own a broadly diversified index fund, such as one that tracks the S&P 500, you can typically expect solid returns over time.

When it doesn’t

There are a few scenarios where it may make more sense to take the cash from dividends rather than reinvesting them:

1. You need the money. Many people invest in dividend-paying stocks because of their income generation. If you’re relying on dividend income to meet your spending needs, it won’t make sense to reinvest the cash.
2. The dividend investment doesn’t have a great long-term outlook. Reinvesting in something with low expected returns isn’t going to lead to much wealth creation. Of course, if you have low return expectations for an investment, you might ask why you own it at all.
3. You have diversification concerns. You may also prefer to take the cash if you have concerns about having too much exposure to a single asset, such as an individual dividend stock. If the stock performs well and you keep increasing your position through dividend reinvesting, the stock could become an outsized portion of your portfolio. 

Bottom line

Dividend reinvesting can be a sound strategy for growing your portfolio over the long run and could even help you become a millionaire. However, reinvesting your dividends doesn’t make sense in every scenario, so you’ll want to consider your own financial needs. Consider working with a financial advisor if you’re not sure which approach makes the most sense for you.

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.