Cashing in on dividends
The simplest ideas are often the best. The good old pencil for instance still holds pride of place next to laptops across many homes. Simplicity in investing though? Investing in dividend paying companies can be both deceptively simple and surprisingly powerful. At a time when banks are paying out a paltry 0.25% interest rate, we investors need to look for alternative money-making income sources. If you already own stocks then the likelihood is that some of them will be paying out dividends.
By owning shares in well-managed businesses, you’re joining your wealth to their success. As a shareholder, you’re entitled to a share of any profits distributed as dividends. And if you don’t need those dividends today you can use them to buy more shares, meaning you earn more dividends in future. This compounding effect was called the eighth wonder of the world by Albert Einstein, and if it gets the Einstein seal of approval it’s got to be a good thing!
Over the long-term, reinvested dividends can become incredibly powerful. The FTSE All-Share has grown by 214% over the last 25 years, but with dividends reinvested this figure trebles to 644%! This is an amazing increase in value but of course, it’s only looking back in time and doesn’t necessarily mean that the same will also happen in the future.
Cash isn’t always king
Bear in mind though that there are risks. Unlike cash which shouldn’t fall in value, the value of stock market investments and the income from them can fluctuate, meaning there is a risk of loss if you time the market badly. Not only that, but the value of dividends can fluctuate depending on how well the company is doing. But compared to holding cash, stocks offer much better returns.
Admittedly cash shouldn’t fall in value, but then it won’t rise much either, especially with interest rates so low.
In contrast, successful companies are always innovating and finding new ways to improve their appeal, generate more cash and ultimately increase their dividends to shareholders. It’s also worth remembering that a rising dividend often accompanies a rising share price. So investors could benefit from potential growth in the value of their capital as well as their income. Win-win!