The benefits of reinvesting dividends, which could increase your wealth by thousands

Businesses that pay dividends can be a dependable source of income for your portfolio, but by failing to reinvest dividends, millions of investors may be losing out on thousands of pounds

Reinvesting dividends is a reliable method of increasing returns and raising the likelihood of long-term, disproportionate gains from your investments. But when choosing the best stocks and funds to invest in, a lot of investors are losing out.

A company's payments to its shareholders, which represent a portion of its profits, are known as dividends. They can be distributed in the form of cash or more stock, and they give businesses a means of telling investors about their achievements.

In order to preserve their capital and ensure its growth, investors frequently only take out dividends, removing the excess funds from their fund to receive income, particularly in retirement when they are part of a pension. This is how investors are supposed to receive dividend income from certain investment funds.

Long-term academic studies on the returns from UK equities have demonstrated that, despite the fact that dividend-bearing investments are especially crucial for income seekers, they overwhelmingly account for the majority of the British stock market's real return (after inflation). "When dividends are reinvested instead of taken, this creates a very powerful compounding effect," stated Jason Hollands, managing director at wealth manager Evelyn Partners.

This implies that in addition to the returns on their initial investment, investors also profit from dividend gains that are reinvested in additional share purchases.

Dividends from the FTSE 100 being reinvested.

The FTSE 100 has generated a 391 percent capital return over the past four decades. This is equivalent to 205 percent in real terms, or after inflation, since Evelyn Partners calculated that the UK consumer price index increased by 186 percent during this time.

The overall return, however, is a much more remarkable 1,926 percent when UK dividends are reinvested.

Ad hoc dividend income can be pleasant to see in your bank account, but if you don't need the money right away, it's much better to choose a dividend reinvestment plan, according to Hollands.

Alternatively, if you invest in funds, you can select accumulation share classes, which automatically roll up any income from the fund portfolio instead of distributing it.

According to Tom Stevenson, investment director at Fidelity International, there is a misconception that the FTSE 100 has consistently underperformed: "And it's easy to understand why if you just look at the headline index level.

It was on New Year's Eve 1999, at the end of the century, that the UK blue-chip index reached its peak of 6,930. It took nine more years to reach 8,000 after it didn't return to that level until February 2015. It's been an arduous labor.

He noted that the overall return from UK shares "becomes much more intriguing when you take into account the relatively high dividend yield on UK shares, which is frequently above 4 percent."

By reinvesting dividends, the FTSE 100 returned to its 1999 peak in February 2006 instead of February 2015. Stevenson stated that compared to the height of the . dot com bubble, the total return index is now more than three times higher.

Failing to reinvest dividends.

However, according to dividend research from Aberdeen Asset Management, millions of investors may be losing out on thousands of pounds each if they don't reinvest their dividends.

Aberdeen's research indicates that 42% of UK investors, or 7.5 million investors, either replied "no" or "don't know" when asked if they were reinvesting their dividends.

Aberdeen's analysis examined the effects of reinvesting dividends on returns if an investor had begun with a £10,000 lump sum investment and took a look at nine major markets over a ten-year period ending in February 2025.

The Dow Jones Index showed the largest disparity between total return (profits reinvested) and capital return (profits not reinvested). It produced 37,016 over a ten-year period on a total return basis. On the basis of capital returns, this is equivalent to 29,651, a difference of 7,365 over a ten-year period.

Given that the US is not usually linked with dividends, some people might be shocked to see the Dow Jones Index lead in this case. However, that merely demonstrates the strength of the compounding effect and how it affects the performance of the index by increasing the total return.

Because, although the SandP 500 yielded the highest total return on investments of £10,000 over a ten-year period (41,485), the difference between capital and total return was smaller (6,786) when compared to 34,699 on a capital return basis.

Third-placed was the FTSE World Index, which had 32,002 returns on a total return basis and 25,439 returns on a capital return basisa 6,563-point difference.

The AIM market showed the biggest difference. Only ten years later, and only on a total return basis, did AIM produce positive returns. E. yielding 11,335 when dividends were reinvested as opposed to 9,851 when they weren't.

Interestingly, Aberdeen's analysis ranked the FTSE100, which is well-known for its dividends, at number five. It yielded a total return of 18,548 over ten years, compared to 12,682 on a capital return basisa 5,866 difference.

"Reinvesting dividends is essential to long-term returns," stated Ben Ritchie, Aberdeen's head of developed market equities. Even though there has been an impact over the last three and five years, the real magic of compounding doesn't start to work until ten years later, provided that markets are trending upward.

A large number of income investors depend on their consistent dividends to cover their expenses. However, compound interest is what helps portfolios grow to a size that allows them to later benefit from income rewards.

Source: February 28, 2025, Bloomberg.

Selecting recipients of dividends.

In addition to the significant impact of dividend reinvestment, there is another reason to search for dependable, consistently dividend-paying businesses.

Hollands stated that "a company can be regarded as shareholder friendly and able to generate healthy cash flows if it is able to pay a dividend that is sustainable and growing and that is adequately covered by its earnings per share." It is necessary to exercise caution, though, particularly in cases where the dividend yield seems "too-good-to-be-true."

When purchasing shares with high dividend yields, Hollands advised against being tempted by the highest headline yields without further investigating how strongly the underlying profits support those payouts.

The market may not think the dividend payout rate is sustainable and the company's outlook is poor, so aiming for higher yielding stocks can be a bit of a trap. A low share price can give the impression that the yield is high.

Finding businesses with the potential to increase their dividends over time is preferable because the underlying operations are doing well. Hollands stated that share buybacks may be taken into consideration in addition to dividends because they have been adopted by many companies recently and can improve shareholder returns.