When investing for your future, the most important factor on your side is time. The power of compounding your returns is what will create real wealth in your account, as long as you do it the right way from the start. One of the most important things to do is to have your dividends reinvested automatically, and to do this with every dividend-paying stock you own, no exceptions.
You'll be surprised at the kind of impact this can have over a long period of time with your favorite stocks, and will want to enroll your entire portfolio in a DRIP right now!
Why you should use a DRIP
A Dividend Reinvestment Plan, or DRIP, is basically a way to have your dividends automatically invested into new shares of stock. All of the major brokerages offer this service, and you can use it for virtually any dividend stock.
These reinvestment plans work so well because it lets you harness the power of continuous compounding without having to pay commissions. This is an especially good system to use in a retirement account because it allows for tax- and commission-free growth of high-income stocks.
Reinvesting vs. Income results
To illustrate the importance of reinvesting dividends, let's take a look at Wells Fargo (WFC -0.77%), which is considered one of the most solid bank stocks around, and has historically paid pretty good dividends. I'd like to consider two situations for a hypothetical $10,000 investment over 30 years (or 120 quarterly dividend payments): reinvesting dividends with a DRIP or simply collecting the dividend income from your shares.
First, if you had invested $10,000, your shares would have appreciated in value to about $443,000 and you would have earned just over $137,000 in dividend income along the way, for a total of approximately $580,000. Not too bad, right? That's a profit of $570,000 on our initial investment!
With a DRIP, the final value of your $10,000 investment would be more than $1,160,000, or about $20,000 more than without automatic reinvestment. Put another way, the $1,200 or so in commissions you would have paid by not enrolling in a DRIP cost more than $20,000 in gains. The commissions do indeed cost a lot more than $9.99 each over the long run! $20,000 can mean being able to buy a new boat, or help your grandchildren out with their tuition when you retire, and it is silly to give up those extra earnings when it is so easy to let a DRIP work for you.
Your future depends on it!
While this is a good example of the power of compounding dividends commission-free, also consider that this effect gets amplified even more the longer that you use it. This could make a tremendous difference in how your retirement nest egg grows over the next several decades, so it is absolutely imperative that each and every dividend-paying stock you own is enrolled in a DRIP.