This Mistake Could Cost You $3.8 Million

Plenty of investors just like you have recently discovered just how well high-quality dividend-paying stocks can help cushion the blow from market downturns. The real value of stocks that pay healthy dividends, though, comes from their long-term performance. And if you want to get the most you can from those dividends, you have to make sure to do the right thing with those quarterly payments when they come in.

The choice every dividend investor makes
One of the biggest decisions that anyone who invests in dividend-paying stocks has to make is what to do with the money they receive. Clearly, when you see that cash go into your brokerage account, you've got a few choices:

• You can pull it out and spend it.
• You can leave it in your brokerage account, and once you have enough cash you can buy shares of another stock.
• You can immediately reinvest it in additional shares of the stock that paid the dividend.

So what's the right choice? Well, that obviously varies from person to person. If you're a retiree who's trying to live off your investment portfolio, then your primary purpose for owning a dividend payer may be to use that income for living expenses.

But if you're in a position in which you don't need to spend that money, then most of the time, you're going to be much better off reinvesting those dividends. Here's why.

The huge advantage of reinvesting dividends
Reinvesting dividends is just another way of setting up an automatic investment plan for your portfolio. Rather than taking additional money out of your bank account every three months to buy more shares of stock, dividend reinvestment diverts the money that would otherwise go into your brokerage account into a new stock purchase. Because many brokers allow you to do this without any additional transaction fees, nothing could be simpler.

It turns out that reinvesting dividends makes a huge difference to your net worth over time. As an example, take a look at what investors who owned these seven stocks would have after 30 years, depending on whether they chose to withdraw and spend their dividends or reinvested them into additional shares:

Source: Yahoo! Finance.

You can see from these examples just how extreme the difference can be. Buying shares of General Dynamics 30 years ago could have made you a multimillionaire -- but only if you kept plowing those dividend payments back into additional shares. Receiving continual income may have given you spending money along the way, but it also cost you $3.8 million over the years.

How is all this possible? Great companies whose stocks pay consistent dividends tend to share two important traits:

• Their businesses grow over time, generating more income and allowing them to build a long track record of raising their dividends, turning dividend reinvestment into a money-making feedback loop.
• By regularly buying shares quarter after quarter, those who reinvest dividends inevitably end up making some purchases at relatively low prices, therefore picking up shares at a bargain when few others are taking advantage.

Don't blow it
So if you've decided that you want to invest in dividend-paying stocks, great -- but just owning them will only take you part of the way toward maximizing your wealth. Only by reinvesting those dividends will you tap into the full potential that those stocks offer. Before you take the cash and run, think twice about whether you can afford to give up the chance at real riches.

Dividend stocks can make you rich, but you don't want to buy the wrong ones. Read which three stocks Fool contributor Ilan Moscovitz thinks could be the next dividend burnouts.