Investing: Expert explains the ‘one golden rule’
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Simply leaving cash on deposit in the bank isn’t enough as even best buy savings accounts pay just one or two percent, while inflation is forecast to rocket past eight percent in April. But investing can help your money retain its value as consumer prices rise.
Everyone should try to save under their own steam if they can, either in personal pension or via their tax-free £20,000 Isa allowance.
The stock market has been bumpy lately, but should still generate a far superior return to cash over the longer run.
This simple trick will make help you make the most of investing, so that you can even make money when share prices are flat.
Most ordinary people who invest in a pension or Stocks and Shares Isa put their money in a spread of investment funds.
These reduce risk by buying dozens of different companies to reduce the damage if one or two fail.
Many of these companies will pay dividends to shareholders as a reward for holding their stock. Your fund manager will pass these onto you, on top of any capital growth as their share prices rise.
Now here’s the trick.
Your fund manager or investment platform will give you the choice of taking those dividends as income, or re-investing them back into your portfolio.
If you are still working and building for wealth or retirement, you should almost certainly REINVEST them.
If you do that, your reinvested dividends will buy more shares, and this will turbocharge your total return. It’s a simple tick box exercise, but you have to give the right answer, because it will make a massive overall difference to your total return.
At time of writing, the FTSE 100 trades at 7,544. Incredibly, that is only 614 points higher than it stood on December 31, 1999, more than 22 years ago.
On that date, FTSE 100 closed at 6,930. It trades just 8.89 per cent higher today. However, if you had invested £10,000 in 1999, your money would have more than doubled to £23,700 today.
You will have made a total return of 137 per cent, according to AJ Bell.
How is that possible? Through the power of reinvested dividends.
They would have continued to buy more shares over the last couple of decades, at much lower prices than today.
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In March 2000, global stock markets crashed following the end of the dot-com tech stock boom, and took several years to recover. They crashed again after the September 11 terror attacks in 2001, financial crisis in 2008 and 2020 Covid pandemic.
Your reinvested dividends would have automatically bought cut-price shares on every occasion, and your pension or Isa will have reaped the benefit.
Laith Khalaf, head of investment analysis at AJ Bell, said reinvesting dividends makes stock market volatility work in your favour. “You actually benefit if shares fall, because your reinvested dividends pick up more stock at the lower price.”
The longer your investment timeframe, the greater the benefits, said Lee Wild, head of equity strategy at Interactive Investor. “Between January 1, 1986, and March 31, 2022, the FTSE 100 delivered a total return of more than 2,010 percent.”
That would have turned £10,000 into a staggering £211,000, but again, only if you had reinvested all your dividends.
When you retire, you can then tick another box, saying you now want to draw your dividends as income.
Then you can use those regular shareholder payouts to boost your State Pension income and fund a better retirement.
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