THE POWER OF REINVESTING
Jerry Sutton, Past President, OKI Tri-State Chapter
We all have the four BetterInvesting basic investment principles memorized. Right? But what is the significance and underlying power of Principle #2:
Reinvest all Earnings (dividends, interest, capital gains).
The cornerstone of this principle is the 'compounding' of your gains. Compound interest (dividends, capital gains) is where one gets 'interest-on-interest' (or 'dividends-on- ... etc.). In other words your income this year contributes to additional income in the next and subsequent years. To see the impact of this, let us look at a simple example.
Assume you invest $100.00 in each of two passbook accounts paying 10% interest (the 'good old days'). On the first account you get 'simple' interest; however, on the second account you get interest that is to be 'compounded' annually. You maintain these accounts for 10 years during which the first account would pay you $10.00 per year (which you spent!) for a total of $100.00 and of course you still have your deposit of $100.00. The second account at the end of 10 years would be worth $259.37. Thus instead of earning a total of $100.00 over the 10 years, you would have earned $159.37. In this instance the power of compounding was nearly a 60% premium.
Of course, if you are reinvesting dividends as a DRIP (dividend reinvestment program), you have the additional benefits of 'dollar cost averaging' and appreciation of the stock, which are also major underlying attributes of Principle #1. But that discussion is for another time.