If you own dividend paying shares, but aren't dependent on the income from them, you may want to consider using the money to buy more shares. They, too, will generate dividends to reinvest, and so on. It's called compounding and the cumulative effect over a number of years can be astounding.
Let's assume you bought 1,000 shares in XYZ Plc for 400p each with a yield of 4 per cent (16p a year). Let's also assume it grows the dividend by 5 per cent a year - not overly optimistic - and its share price increases by a similar figure.
Over 20 years, the stake would be worth £16,200, including £5,500 of dividends, giving an annualised return, or compound annual growth rate (CAGR), of 7.2 per cent. However, if you had used income from the original holding to buy shares in the company, your investment would now be worth £23,200 (£8,800 of dividends used to buy shares), a return of 9.2 per cent.
If that same stock had paid out 6 per cent each year, the final stake would have been worth over $34,000 - an annualised return over 11.3 per cent.
