The power of reinvesting Gains and Dividends
Most but not all fund investors reinvest their dividends and gains payouts. Great move if you are a long-term investor.
I mentioned last week that one of my hero’s, Peter Lynch was one of the greatest stock pickers of all time. Mr. Lynch managed one of the greatest funds of all-time in the Fidelity Magellan Fund.
Let’s examine the power of compounding by reinvesting Dividends and Gains back into this fund.
If you invested $100 in the Magellan Fund back in December of 1984 and automatically reinvested both the dividends and capital gains back into the fund, meaning purchased more shares; your initial $100 investment would have turned into $608 by 1995. This is a whopping 508% return.
Now let’s look at the returns if the Dividends were not reinvested. The initial $100 invested in December of ’84 would have “only” returned 424% or a total of $524. Not bad but you can still see a major difference in total return and the amount you would have had in 1995.
Let’s take this one step further. We invest $100 in December of ’84 and decide not to reinvest the dividends or the capital gains back into our fund. Our $100 in ’84 turns into $230 or a return of 130%.
The average return on an annual basis of this Magellan example is as follows: 19% average annual return when BOTH Dividends and Capital Gains are reinvested, 17.4% avg. annual return when only Capital Gains are reinvested and 8.5% return when neither Div or Cap Gains were reinvested.
Not all Funds have created the kind of returns that the Magellan fund has but they all work the same way. Regardless of the true return, all funds have higher rates of return and help you grow your money faster by simply electing to have your Dividends and Capital Gains reinvested back into your fund.
Moral of the story, as a long-term investor, make sure to ALWAYS have both dividends and Capital Gains reinvested back into your fund. If you allow the dividends and Capital gains to be distributed to you and not back into the fund itself, you are missing out on the powerful effects of compounding.
Speaking of compounding
The path to creating a fortune for yourself is to strategically select a proven Growth Stock Fund, reinvest the Dividends and Capital Gains and allow compounding to do its magic. Compounding occurs because the earnings of the funds buy more shares and produces more earnings. You now have more shares producing more earnings and even more earnings plowing back into the fund creates even more earnings. What a beautiful cycle!
In an article from U.S.News.com not only emphasizes the importance of reinvesting your dividends and capital gains but reiterates the point I make to all my passive students: Setup your investments on an automatic plan, not only your automatic reinvestments but the money you have directed to a Roth IRA, Traditional IRA or other savings and investment vehicles.
Below is an important clip from the article mentioned above:
Make the most of compound interest by staying invested. Reinvesting "keeps you from having a cash drag on your returns if you do not reinvest the cash dividend right away," Rodgers says. The upside to automatically adding to your investments is that you're saving no matter what. Behavioral finance studies show that by making your savings automatic, you are more likely to save than if you need to actively choose to do so. In a study published by the National Bureau of Economic Research, Harvard University researcher Brigitte Madrian found that the number of participants in workplace savings plans nearly doubled when people were "auto-enrolled," compared to the number who did so if they needed to opt in to a plan. Dividend reinvesting applies the same principle.
Until next week, hit me up with any questions or topics you’d like to cover in the future.
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