Since April 1, 1995, the S&P 500 (^GSPC -0.22%) has returned 318%. That's a respectable gain, especially considering the calamity of the financial crisis in 2008 and 2009.
But that 317.6% could be a whole lot higher. How much? Try 192.2% higher. The key is a fundamental but often overlooked investing practice: reinvesting dividends.
The numbers are incredible
The easiest way to understand just how powerful dividends can be is to use a measure called the "total return price." Total return price is a theoretical measure of a stock's price that includes both the stock's appreciation and its dividends paid.
Total return price breaks down like this. You invest $100 in a stock. Over the course of a year, the stock appreciates by $50 and the company issues a $10 dividend. Your investment therefore earned you $60 for a 60% total return. Here's a chart breaking down the S&P 500's percentage change over the past 20 years with and without reinvested dividends:
The longer you hold the stock, the better the total return price performs relative to the price alone; those reinvested dividends accelerate your investment's compound gains.
Some powerful examples
For long-term investors, reinvesting dividends is one of the most powerful investing tools in their toolbox. Consider IBM (IBM -0.89%).
Big Blue, as IBM is sometimes known, is a stalwart of American business. The company has been around for over a century, having reinvented itself time and again with fantastic success (though the jury is still out on the company's current evolution). And for investors, IBM has one of the most reliable dividends around: It has paid a dividend every quarter since March 1916!
Over the past 20 years, the company's stock has appreciated 685%. That's a great return by any standard, more than doubling the S&P 500 over the same period.
However, with dividends reinvested over that period, IBM's total return is a whopping 906%! That's 321% better than the stock appreciation alone.
Still not convinced of the power of reinvested dividends? Check out Wells Fargo (WFC 2.73%). Like IBM, Wells has been around for well over 100 years and is one of the top companies in American business today. Wells is the largest U.S. bank by market cap and regularly produces industry-leading returns on assets and equity.
Accordingly, the stock price has appreciated handsomely: It's up 752% over the same 20 year period. However, if you were a Wells investor who also reinvested dividends, that 752% return would transform into an incredible 1,330%. That beats the S&P 500 by a factor of 2.6!
Now a quick word of warning
Reinvesting dividends is a fantastic strategy. It could supercharge your returns over time, building wealth when you're young and extending your retirement funds when you leave the workforce.
There are, however, a few things to consider. First there are fees. Depending on how your brokerage or retirement account is set up, you could be paying unnecessary fees to reinvest your dividends. These fees could be shown as transaction fees or as commission fees. Make sure you read the fine print and take the steps to minimize or eliminate any fees. After all, taxes and fees are the two biggest reason investors lag the markets.
Further, there may be an opportunity cost in reinvesting your dividends into the issuing company instead of alternative investment vehicles. In our examples above, Wells Fargo outperformed IBM by a pretty decent margin. Reinvesting your IBM dividends into Wells Fargo stock would have generated a higher overall return.
That said, it's next to impossible to correctly make those judgement calls without the benefit of hindsight. My recommendation is to keep it simple and reinvest directly into the issuing company. That has the added benefits of automation and keeping your transaction fees down.
What to do next
If you aren't sure whether your dividends are being reinvested, now is the time to check. If you're already following this practice, now is a great reminder to double check that you aren't paying excessive fees and to consider your portfolio's diversification.
Reinvesting dividends is a no-brainer for investors young and old. It's a simple, effective, and powerful tool to supercharge your investing.
