Supercharge Your Savings: How Reinvesting Grows Your Wealth Automatically

Imagine planting a seed in your garden. You water it, and it grows into a plant that produces more seeds. If you simply admire the new seeds and do nothing with them, your garden stays roughly the same size. But, if you take those new seeds and plant them too, you’ll have even more plants next season, and even more seeds! This is similar to how automatic reinvestment works in investing, and how it helps you benefit from something called compound returns.

Let’s break this down. When you invest in something like stocks or bonds, you might receive payments over time. For stocks, these payments are called dividends – a portion of the company’s profits given back to shareholders. For bonds, these are called interest payments – essentially the cost of borrowing money from you. These payments are your returns on your initial investment.

Now, you have a choice when you receive these payments. You could take the cash and spend it, which is perfectly fine. However, automatic reinvestment offers a different path, one that can significantly boost your long-term wealth.

Automatic reinvestment means that instead of receiving those dividend or interest payments as cash, you automatically use that money to buy more of the same investment. Think back to our garden analogy. Reinvesting is like taking those new seeds and immediately planting them back into the garden.

So, how does this help with compound returns? Compound returns are often described as “returns on returns.” It’s the magic of your money making money, and then that money also making money. Let’s illustrate with a simple example.

Imagine you invest $100 in a stock that pays a 5% dividend per year. After the first year, you receive $5 in dividends (5% of $100).

Scenario 1: No Reinvestment
If you don’t reinvest, you simply take that $5 as cash. In the second year, assuming your stock still pays a 5% dividend and the stock price remains the same, you’ll again receive $5 – 5% of your original $100 investment. You’re earning returns only on your initial $100.

Scenario 2: Automatic Reinvestment
If you have automatic reinvestment enabled, that $5 dividend is automatically used to buy more shares of the same stock. Let’s say with $5, you can buy a small fraction of another share. Now, in the second year, you’re not just earning dividends on your original $100, but also on the additional shares you bought with your first dividend payment. So, you’ll earn slightly more than $5 in dividends in the second year.

This might seem like a small difference at first, but over time, it becomes incredibly powerful. Each year, you’re earning returns not just on your initial investment, but on all the returns that have been reinvested. It’s like a snowball rolling downhill – it starts small, but as it rolls and gathers more snow (reinvested returns), it grows larger and larger at an accelerating rate.

Automatic reinvestment is a powerful tool because it takes the effort out of compounding. You don’t have to manually decide to reinvest your dividends or interest. It happens automatically, consistently working in the background to grow your investments. This is especially beneficial for long-term investors. The longer you reinvest, the more time compound returns have to work their magic.

Think of it as putting your money on autopilot for growth. By automatically reinvesting, you are essentially telling your money to keep working for you, even while you sleep. It’s a simple yet highly effective strategy that can significantly enhance your investment returns over the long run and help you reach your financial goals faster. So, if you have the option to automatically reinvest dividends or interest in your investment accounts, it’s generally a very wise choice to harness the power of compounding.