Reinvesting Dividends Can Help You Earn Money in Your Sleep: Here’s Why

There’s a timeless investment strategy that’s older than most publicly listed companies today. The strategy involves only a little time and effort, and it can accelerate compounding in your portfolio to a great degree. There are no fees. Plus, you can set the strategy to automatic in your brokerage account for consistency. It sounds almost too good to be true.

The strategy is called dividend reinvestment, deployed by beginner investors and some of Wall Street’s most seasoned professionals, such as Warren Buffett. Dividends are rewards (usually cash) that a company or fund gives to its shareholders on a per-share basis. Companies with good profits and excess earnings can reinvest the cash in operations, pay down debt, or pay a dividend to reward shareholders.

Image source: Getty Images

High inflation, slowing GDP growth, the Russia-Ukraine war, and supply chain challenges are all straining the stock market. In short, it’s a reminder of the power of utilizing a diversified portfolio that isn’t too concentrated in any single sector. Some investors prefer to “go defensive” in such times, or convert their portfolio to a more conservative stance. One way to accomplish this: dividend stocks, which are reliable, and their dividend yields represent a steady income stream even when markets turn south.

How it works: Your dividends buy more shares, which increases your dividend yield the next time, which lets you buy even more shares, and so on. For example, assume you own 1,000 shares of a stock at $100 per share, for a total investment of $100,000. Assuming a 3% dividend yield, that’s $3,000 in dividends you can reinvest right back in your investment.

How to reinvest dividends

Investors can enroll in automatic dividend reinvestment programs through their brokerage account, usually in the account settings menu. You’ll have the option to automatically enroll all current and future stocks and funds or select individual stocks and funds to automate.

Some investors pocket dividends as cash to pay off bills or invest in other stocks. But automatically reinvesting them can pay off, especially over longer time horizons of several years (or longer). Dividend reinvestment is cheap and automatic, with no fees. It’s easy, flexible – you can acquire fractional shares via dividend reinvestment – and consistent: You can buy shares on a regular basis, such as each quarter.

Dividends don’t have to be merely for retirees

You’ve probably heard stories of retirees who live off dividend stocks. It’s a dream for many people to simply cover their costs in retirement thanks to their quarterly dividend payments. The strategy helps preserve capital and generates a growing income stream, regardless of market conditions. For those retirees, not reinvesting your dividends may make the most sense, so you can have that cash on hand when you need it. Additionally, dividend reinvesting may not be a sound strategy for people who need those dividends to cover bills, pay off debt, or balance out their portfolio.

But for many investors, no matter your age or investing experience, automating your dividend reinvestments is an important mechanism to drive return. DRIP (Dividend Re-Investment Programs) allows investors to benefit from dividends in a hands-off way.

It’s also a perfect use case of dollar-cost averaging, a strategy in which an investor divides up the total amount to be invested across periodic purchases of a target asset class to reduce the impact of volatility. Purchases occur regardless of the asset’s price and at regular intervals.

Investors can supercharge growth by setting up mechanisms to reinvest dividends. Just as staying invested through the market’s inevitable ups and downs helps you avoid missing out on the best days, automatic dividend reinvestment is another low-effort way to grow your wealth.

10 stocks we like better than Walmart
When our award-winning analyst team has an investing tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

They just revealed what they believe are the ten best stocks for investors to buy right now… and Walmart wasn’t one of them! That’s right — they think these 10 stocks are even better buys.

See the 10 stocks

Stock Advisor returns as of 2/14/21

The Motley Fool has a disclosure policy.

Leave a Reply

Your email address will not be published.