Stocks that pay healthy dividends have helped investors create fortunes over the years. But if you forget one simple step along the way, you'll end up with only a fraction of the nest egg you could have had.

Dividend-paying stocks give you have two great features that you'll especially like at times like these. Not only do they give you a reassuring payout every quarter, but they also tend to be less volatile than stocks that don't pay dividends. Those two features will help any investor sleep better at night.

Don't take the money and run
But if you really want to cash in on dividend stocks, there's one thing you have to do: Take that money and reinvest it to buy more shares of stock.

Now, that might seem strange at first -- after all, if the company just paid me money, why should I just send it right back? As it turns out, reinvesting those dividends is far more likely to make you rich than just buying a stock and hoping its shares will rise in value over time.

Want proof? One study showed that from 1960 to 2005, about 80% of the returns from the stock market came from reinvested dividends. Looking at an even broader timeframe -- from 1871 to 2003 -- dividends account for fully 97% of the market's returns.

Looking at stocks
To see the value of reinvesting dividends up close, let's take some popular stocks and pretend you had bought $10,000 worth of stock 20 years ago. We'll then compare how much you'd have by reinvesting dividends, versus what they'd be worth if you just took the dividend cash and spent it:


Value Without Reinvesting Dividends

Value With Dividends Reinvested

Pfizer (NYSE:PFE)



PepsiCo (NYSE:PEP)



United Technologies (NYSE:UTX)



Johnson & Johnson (NYSE:JNJ)



Coca-Cola (NYSE:KO)



ExxonMobil (NYSE:XOM)



Procter & Gamble (NYSE:PG)



Source: Yahoo Finance.

Convinced? There are plenty of reasons why this works:

  • As a company grows, it typically increases its dividend. So over time, your dividend payments get bigger in comparison to what you spent on your shares in the first place. After many years, you'll have bought far more shares from dividends than you did with your original investment.
  • Dividends give you many of the benefits of dollar-cost averaging. When share prices are low, your reinvested payouts buy more shares.
  • Reinvesting lets the magic of compound returns work more effectively, by stopping the leaks that result from taking dividends in cash.

If you're interested in reinvesting dividends, how do you do it? There are a couple ways to go.

Drip your way to wealth
Many companies let you buy shares directly from the company, both for an original purchase and by reinvesting dividends. These dividend reinvestment plans offer you the ease of automatically buying more shares with your payouts. You'll typically even be able to buy fractional shares if your dividends aren't enough to buy a full share of stock.

But the downside of Drips is that they don't let you buy or sell shares as easily as you could via a brokerage account. To meet customers' demands, however, many brokers now let you reinvest dividends automatically on stocks you hold in your account. That way, you can have the convenience of tracking all your stocks in one place, while still reinvesting dividends.

In figuring out which method to use, be sure to consider any fees charged. Because dividend amounts can be relatively small, you don't want to have to pay large regular charges for the privilege of automatic reinvestment. Those expenses could eat away at the long-term benefits of reinvesting.

However you set it up, though, you owe it to yourself to start reinvesting your dividends today. Your future self will thank you!

For more on how your broker can help you, read about:

Learn how you can pick the right broker to help you reinvest your dividends. And to find the best stocks, take a look at our Motley Fool Income Investor newsletter. Each month, you'll find great discussions of stocks, bonds, and other income-producing investments. Sign up now and see how Income Investor can help you -- it's free with a 30-day trial.

In the first investment he ever made, Fool contributor Dan Caplinger now owns more shares thanks to dividend reinvestment than he originally bought. He doesn't own shares of the companies mentioned in this article. Pfizer and Johnson & Johnson are Motley Fool Income Investor recommendations. Wal-Mart, Pfizer, and Coca-Cola are Motley Fool Inside Value recommendations. The Fool owns shares of Pfizer and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. You can't miss the Fool's disclosure policy.