Anyone who’s ever dealt with faulty plumbing knows how a small leak can grow to become a major problem. Each tiny drop of water from a leaky faucet or pipe eventually fills up buckets! Drop by drop, that seemingly insignificant drip creates a real headache in your kitchen or basement.
Investors should keep this lesson in mind as they build their long-term portfolios. It’s not that you should ask your plumber for investing advice, but that pennies and dollars invested on a regular basis can add up to a great amount over time.
Take dividends, for instance. It’s easy to ignore the dividends that you might be receiving on stocks that you own. Dividend yields are pretty low on a historical basis, and after all, what’s a few cents? But just like a leaky faucet, those dividends can add up over the years – especially if you reinvest them in purchases of additional shares of stock.
In fact, you might be shocked at just how much dividends can contribute to the overall returns generated by a portfolio of stocks over the course of many years. Since 1952, the stocks in the S&P 500 have provided a simple return of 7.65 percent a year. If all dividends were reinvested on a quarterly basis, however, the total return would have jumped (or perhaps vaulted is a better term) to 11.50 percent a year.
In the short term, dividends won’t make as much of a difference in the returns in your portfolio. As of mid-April 2003, the dividend yield of the S&P 500 was just 1.5 percent — less than two pennies on each dollar invested.
The whopping difference in long-term returns only comes with many years of growth, allowing the power of compound returns to work on your behalf. Just as interest earns interest in a bank savings account, giving you a higher yield than if you withdraw each month’s interest payment, shares purchased with reinvested dividends will grow and pay even more dividends – if you give them enough time. Of course, dividends and returns can and do vary.
It’s easy to put the power of reinvestment to work if you own a ShareBuilder portfolio. And there’s no cost to do it – it’s FREE! Just make sure that you have selected Yes under Dividend Reinvestment Preferences in your account profile. Then all future dividends you receive will be automatically reinvested in additional shares of stock, with no commissions or fees to pay.
And it’s not only dividend reinvestment that we’re talking about here. You should make it a plan to reinvest all your investment earnings, whether they come from dividends, interest or gains from selling shares. And while it’s easiest to simply reinvest dividends in shares of the company’s own stock, you could choose to invest the dividends in shares of other stock. If you regularly withdraw funds from your investment accounts – even if it’s "only" a few pennies or a few dollars – you can do a real disservice to your long-term financial goals.
The lesson here is clear. Maintain your focus on a long-term horizon and keep all of your investment funds working for you in the stock market, even the amounts that seem like dribs and drabs today. Down the road, you’ll more than likely be glad you did.