The main character in Kurt Vonnegut, Jr.'s 1965 book, God Bless You, Mr. Rosewater, is an eccentric philanthropist. He thinks it's unfair that babies don't all start with an equal playing field.
"I think it's a heartless government that will let one baby be born owning a big piece of the country, the way I was born, and let another baby be born without owning anything." To rectify this perceived injustice, he sends one share of stock to each newborn child in the country.
Wouldn't that be a nice start. Of course, we all know a single share of stock wouldn't go too far if you had to live off of it.
But there is a well-known way that you can stretch your investment -- even if it starts as a single share -- to where it can more than provide for any needs you might have.
How Dividend Reinvesting Could Double Your Annual Income Over Time
So how can you make your investment -- no matter how small initially -- turn into something that you can actually afford to live on? Simple: Reinvest its dividends.
Tripling Your Portfolio With 'Rockefeller Stocks' By 2020
Yes, some of you need all your dividend cash right now. But if you don’t need to live off your dividends right away, reinvesting them can be a much better way to create a lasting (and growing) stream of income.
Dividends are one of the most powerful wealth-building tools in an investor's arsenal because of the phenomenon of compounding.
By reinvesting your dividend checks (instead of cashing them), you can buy more shares, which leads to even larger dividend checks. These larger checks can then be used to buy even more shares and so on. In time, even a small stake in such stocks can grow into a tidy sum.
Let’s say you invested $20,000 in a fund that pays a 7% annual dividend yield. If you did not reinvest and simply pocketed the dividends every time they were paid out, you’d collect a flat $1,400 in dividends per year (7% of $20,000 = $1,400).
But let’s say you had time to reinvest your dividends on this investment for the next several years before you needed to live on the income. If you were to reinvest your dividends for five years, you could start collecting $1,964 in dividend income per year starting in year five. That’s like earning 10% interest per year on your original investment ($1,964/$20,000).It gets better. If you reinvested your dividends for 10 years, you could begin collecting $2,754 per year in dividend income by year 10 if you needed the cash. That’s like earning an eye-popping 14% in cash interest per year on your original investment ($2,754/$20,000).
Let’s put this another way to drive the point home. By choosing to patiently reinvest your dividends over 10 years instead of pocketing them every time, you could earn twice as much dividend income per year ($2,754 annually versus a flat $1,400 annually) in this example. And that’s without needing to add a penny to your original $20,000 investment.
I don’t know about you, but I’d take that easy trade off if it meant doubling my annual income.
How to Reinvest Your Dividends
Great news: reinvesting your dividends is easy. In fact, many brokers (online or in-office) will set this up for you when you start investing by default. If that’s not the case and you’re receiving dividend checks that you want to start reinvesting, just give your broker a call and they can take care of it for you in a matter of seconds.
It doesn't take Warren Buffett to see how quickly your income stream can grow when you invest this way. The secret to lasting retirement income is simple: The more you reinvest your dividends and the longer you do it, the larger the dividend checks you can collect when you need to finally "turn off" your reinvestment plan and start living on the income.
P.S. For several years now, my subscribers over at The Daily Paycheck have been using dividend reinvestment to build powerful portfolios designed to throw off thousands of dollars in extra income when they need it most. All it takes is careful research of the best income-paying securities on the market -- and a little patience and discipline. To learn how you can get started, click here
This article originally appeared on Street Authority.