Build Real Wealth

Dividends are probably the most maligned and ignored part of the average investment strategy. More often than not, a dividend payment represents just a tiny sliver of an investor's stake in a business. Given the wild gyrations in stock prices these days, the total value of a year's worth of dividends can be added to or taken away from a company's share price in less than a week.

It's a pity that dividends get so little respect. Those lowly payments, if used to their full potential, can help you build serious wealth. Here's how.

Get cash now
Assume you have a company that sports a 4% yield. For every $1 you invest, you get $0.04 in annual dividend payments. That may not seem like much, but it does mean that over the next 25 years, you'd get your entire investment back in cash -- while keeping the shares that produced it.

Add a sprinkle of growth
I certainly understand if a 25-year payback doesn't seem all that enticing. After all, that's a rather long time, and a lot can change in that period. Fortunately, dividends aren't always static payments. Many companies raise their dividends on a regular basis, as their operations grow and strengthen over time.

With that in mind, let's look at making a one-time $1,000 investment in a company with a 4% current yield whose payout is expected to grow 4% per year.

With that small annual boost, you'll now get your entire investment paid back to you in 18 years -- a full seven years faster than before.

Light the afterburners
While things might be starting to look interesting by this point, it gets even better if you take that cash, but instead of holding onto it, you reinvest it. In other words, use that cash paid out to you to buy even more shares of a company with a decent and growing dividend.

Let's take the same scenario described above, only instead of holding the cash that the company generates, we use it to buy even more shares of its stock. And to keep things fair, we'll assume that the company's stock increases in line with its dividend hikes -- about 4% a year.

Thanks to reinvesting, the equivalent of your entire $1,000 investment would have been paid to you by the end of 15 years, and you'd keep the shares that produced it. In fact, thanks to reinvesting your dividends, after 25 years, your original $1,000 investment would have grown to be worth around $6,340. Most astonishingly of all, by that point, you would have received payments totaling nearly triple your original investment. That's not bad for a meager 4% dividend payment, eh?

This tremendous potential for dividends to improve your overall returns is precisely why my Foolish colleague James Early offers his Motley Fool Income Investor service. It's smart to put the power of compounded dividends to work in your portfolio -- it can really help you achieve your financial goals.

Get real
The best news is that all of these calculations amount to much more than a mere academic exercise. There are hundreds of very real companies out there with a decent history of paying solid dividends and routinely raising those payments. This table contains just a small sampling of those businesses:

Get started now
Real wealth is built over time, through the slow and steady rewards of reinvestment. The sooner you get started, the better your odds of accumulating a substantial nest egg of your own. If you'd like to begin your journey today, join us at Income Investor. If you're still unsure, a 30-day free trial is available here.

This article was originally published on Aug. 30, 2006. It has been updated.

At the time of publication, Fool contributor Chuck Saletta had no ownership stake in any of the companies mentioned in this article. US Bancorp is an Income Investor recommendation. The Fool has a disclosure policy.