This Lazy Dividend DRIP Can Energize Your Returns
Don’t just do something, stand there! — Yep, the phrase is a little twisted. But its the mantra of my favorite dividend DRIP strategy. Sometimes, the very best returns can accumulate when investors are willing to step back and get out of the way. Instead of “doing something” they stand there and let the dividend DRIP strategy work its magic.
Dividend DRIP Harnesses The 8th Wonder of the World
Einstein called it “the eighth wonder of the world.”
Compound interest is one of the most powerful forces in finance — capable of taking a small sum of money and turning it into a material amount of wealth. It just takes time and patience (and a bit of research to find the right stock).
Here’s how it works…
Start with a dividend stock (or another investment that pays you cash). Then when your cash payment comes in, use that cash to buy more of your investment.
Since you will own more shares, your payments will increase. Slowly at first, and then much more quickly as compound interest kicks in. Eventually, your payments will far exceed the small amount of capital that you started with.
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One of the easiest ways to benefit from compound interest is through a dividend DRIP program. (DRIP simply stands for Dividend Reinvestment Program.)
With many stocks, you can buy shares directly from a company, and enroll in that company’s dividend DRIP program. The company will automatically buy new shares for you each time a dividend is paid. You don’t have to do anything but watch your investment grow!
Some 401k plans will also let you set up a DRIP plan. But I would only use a broker’s DRIP plan if there were no additional fees attached. Fees can eat into your returns and really hurt the power of your compound returns.
Strong Returns Without a Dividend DRIP Plan
Let’s take a look at how a DRIP program can boost your returns. We’ll use a real-life example of how compound interest adds up.
Start with an investment in McDonalds Corp. (MCD). We’ll look at the difference between an investor who spends his dividend checks versus an investor who uses a dividend DRIP program:
Thirty years ago on July 1, 1996 MCD was trading at $75.88 per share. (Keep in mind, there have been three stock splits since that time) So it would have cost each investor $7,588 to buy 100 shares of stock.
Since that time, MCD has paid cumulative dividends of $175.73 per original share. So an investor who owned 100 shares during that time period would have received $17,573 in income.
MCD had a 3-for-2 stock split in 1987, a 2-for-1 stock split in 1989, and a 2-for-1 split in 1994. So if you bought 100 shares thirty years ago, you would now be holding 600 shares
On July 1 of this year, MCD closed at $120.40. That means your 600 shares would be worth $72,240. Add in your $17,573 in income and you’d be sitting on a total return of 1,084%. Not bad!
Add An Additional 350% WITH a Dividend DRIP Plan
But what would have happened if each of those dividend payments had been re-invested into new shares of MCD?
An investor who used a dividend DRIP payment would have done far better.
Instead of owning 600 shares of MCD, the re-invested dividends would have purchased an additional 366 shares. This means our DRIP program would have left us with 966 shares. More shares equals bigger dividends, which in turn means even more shares.
All told, an investor who used a dividend DRIP plan would wind up with a total return of 1,434%. That’s 350 percentage points higher than an investor who chose not to reinvest his dividends.
You can see a chart of the two sets of returns below, and here’s A link to my spreadsheet if you want to check my figures.
Of course many investors own dividend stocks because they need dividend payments to cover life expenses. But if you’re investing for the long run and you can afford to reinvest your dividends into a DRIP plan, your returns could be significantly enhanced.