Returns from shares and funds come in the form of a capital gain, if and when they increase in value, as well as dividend payments.
Not all funds and stocks pay dividends but for those that do, reinvesting these payments back into the relevant collective or share can be a highly lucrative strategy.
By putting money into an investment that delivers a consistent income and reinvesting that cash as and when it is received, you capture the returns on your reinvested profits as well as from your original investment. This effect can be even more powerful if the income stream itself is growing.
How does this work? Let’s say you own 1,000 shares in a company which has a share price of 200p and pays an annual dividend of 10p for a yield of 5%.
Then let’s assume you reinvest this £100 payout into the shares. Next year the company has increased its dividend by 10% to 11p and you now own 1,050 shares, meaning you receive a payout of £115.50 which again can be reinvested in the shares to set you up for a larger dividend payment the following year, and so on, and so on.
HOW TO DO IT
How do you go about reinvesting dividends? You can do it manually, waiting until the dividend payment is in your account and then using this money to buy more shares.
However, many investment platforms offer dividend reinvestment services which take the hassle out of this and automatically reinvest income for you – though you will face a modest charge for the privilege.
You can usually elect to have dividends reinvested for one or more specific shares you hold, or you can even opt to have all eligible dividends reinvested for all shares you hold now and any eligible shares you buy in the future.
As many shares as possible will be bought with the dividend with any surplus cash returned to your account.
Investments eligible for a dividend reinvestment service typically include a wide selection of shares, investment trusts and tracker funds as well as exchange-traded funds.
For traditional funds the most straightforward way to reinvest income is to buy the ‘acc’ version of the fund which automatically rolls up dividend payments so you own more fund units.