Free Money

While debate often swirls over the best investing strategy, decades of stock market data support only one conclusion: Nothing beats free money.

Introducing dividends
Jeremy Siegel, the market's so-called demented dividend guru, performed a study of stocks over 200 years and found that real returns equaled about 7% annually, easily the best deal of all asset classes available to investors.

But it was the stocks that paid dividends that did best. From 1957 to 2003, Siegel found that high-yielding dividend payers were far more likely to beat the market. And the highest yielders beat the S&P 500 index by more than four percentage points annually.

What's a dividend? Quite simply, it's a promised cash payout to investors. Think of it as a profit-sharing plan for stockholders, most often paid quarterly. If you hold a dividend-paying stock in a brokerage account, the dividend will show up as a cash deposit on your statement. If you hold certificates bought directly from a company, you'll receive a check in the mail.

Compounding profits
Sure, you could bank the cash, but your best bet may be to reinvest the proceeds and purchase more shares of the company that paid the dividend. Reinvested dividends act like compound interest by increasing your buying power. For example, J. M. Smucker (NYSE:SJM) recently announced a $0.28-per-share dividend to be paid to shareholders on September 1. That's $28 for every 100 shares owned, enough to purchase a 0.609 fractional share of Smucker at its recent closing price of $46.01 ($28 / $46.01 = 0.609).

Next quarter, you'd have 100.609 shares on which the company owes you a cut of its profits. That's $28.17 instead of $28, assuming that the dividend remains steady.

It's thanks to reinvested dividends that Altria (NYSE:MO), formerly known as Philip Morris, outpaced the market by more than 9% annually over the 46 years of Siegel's study, beating all other stocks during the same period.

How to reinvest
Brokers are generally very helpful when it comes to reinvesting dividends. Most often, you'll simply choose an option online to have the dividends from the stocks you own reinvested. Better still, the service is often free. Here's a short rundown of what I learned in a recent survey of popular brokerages.

Restrictions may apply. Please contact your broker for more information.

Follow the money
Sometimes free isn't so good, like getting two ugly shirts for the price of one. All that leaves you with is two ugly shirts you won't wear. But when it comes to stocks and investing, found money in the form of dividends is about as good as it gets. And since the service is free at most brokerages, it's never been cheaper to cash in.

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Fool contributor Tim Beyers reinvests dividends regularly. He also brushes his teeth and eats his veggies. Tim didn't own shares in any of the companies mentioned in this story at the time of publication. Check out all of his stock holdings at Tim's Fool profile. The Motley Fool has an ironclad disclosure policy.