Make one change to your investment strategy and you could double your returns in the long-term, new analysis has revealed. All you have to do is stop taking your dividends.
If you want to dramatically improve your returns you need to start reinvesting your dividends, according to one investment group.
Now, the news that you could earn more by investing more is hardly likely to knock you off your chair, but it's the impact this reinvestment could have on your portfolio that really stands out.
Research by Fidelity International has revealed that you could almost double your returns in the long-term by doing so.
Had you invested £100 a month in the FTSE All Share index since 1988 and taken any dividends as income then you would have a portfolio worth £70,923, according to Fidelity.
But, if you had reinvested all your dividends back into your portfolio it would be worth almost double at £140,585.
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“Dividends matter more than some investors think,” says Tom Stevenson, investment director for personal investing at Fidelity International.
“While growth-focused investors sometimes treat dividends as the icing on the cake, they can be the main driver of investment returns when reinvested.
“Indeed, over very long periods, almost all the gains from investing in the stock market can be attributed to the reinvestment of dividends.”
The magic of compounding
Even over short periods, sinking your dividends back into your portfolio can make a big difference to your returns. Taking the same scenario as above, but only over 10 years rather than 30 the investor who took their dividends would have £15,837.
But, the person who reinvested their dividends would have over £3,500 more with a portfolio worth £19,382.
Over 20 years reinvesting the dividends would have left a portfolio worth £51,674 – almost £17,000 more than the person who took the income.
“The key to understanding why reinvesting dividends has such a significant impact on your total returns lies in the magic of compounding,” says Stevenson.
“For compounding to really supercharge your returns it requires two simple ingredients: time and the regular reinvestment of returns.
"The earlier you start, the more time you have to benefit from the returns on both the money you have initially invested as well as the returns and dividends you have earned on that starting amount.”
A £1,000 boost to your ISA
Reinvesting your dividends can also significantly boost your ISA returns.
If you had invested £1,000 in the FTSE 100 via an ISA back in December 1999 you would have had £1,204 by November last year if you had taken all your dividends, according to Schroders. That equates to an annual return of just 1.1%.
But, if you’d reinvested all your dividends your return would have rocketed by almost £1,000 giving you an ISA worth £2,193, ramping up your annual return to 4.6%.
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“Dividend reinvestment is one of the most powerful investment tools available,” says Nick Kirrage, an equity value fund manager at Schroders.
“In an era when interest rates are so low investors need to be aware of relatively simple investment techniques that can help them build up their returns. Dividend reinvestment is a simple technique.
“Over time, those seemingly small amounts reinvested can grow into much bigger sums if you use them to buy even more shares of stock that pay dividends in turn.”
So, if you don’t need that income reinvest your dividends and give your portfolio a powerful boost.