The Power of Dividends: Compounding Wealth

Dividends are one of the types of returns you can earn from equity shares. Learn about dividend investing strategies to create wealth over the long term.
14 Dec, 2023 09:27am
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When you think of investing in the stock market, you probably focus primarily on the gains you can make from stock price changes. However, there’s also another way to earn from your stock market investments — in the form of dividends. 

 

What are Dividends?

Some companies distribute a portion of their profits to their shareholders in the form of dividends. These dividends can be paid as cash or offered in the form of additional shares in the company. Essentially, dividend payouts allow companies to reward their existing shareholders and also attract new investors. The amount of dividends paid is typically based on various factors like the company’s profitability, its financial requirements and future growth plans. 

 

Compounding Wealth with Dividends: How Does it Work?

Creating wealth is a complex process that can only be achieved if your money grows exponentially rather than just linearly. Here’s where compounding becomes highly significant. Simply put, compounding is the process of allowing your money to multiply by earning income on income. 

 

In other words, when you earn some returns on an investment, whether in the form of interest or dividends, you do not merely save up those returns. Instead, you reinvest them in other investments that generate further returns. In this manner, your returns or gains give rise to more returns over time, leading to an exponential increase in your corpus. 

 

To compound and grow your wealth, you can tap into the power of dividends and make use of some effective dividend investing strategies. Check out some such strategies that facilitate compounding wealth with dividends. 

 

Common Dividend Investing Strategies

Here is an overview of common dividend investing strategies for compounding wealth with dividends. 

 

Dividend Growth Investing

Also known as dividend reinvestment, this dividend investing strategy is based on the notion that the dividends paid out by a growing company tend to increase with time, as the company expands and scales up. So, by owning such dividend-paying stocks, your dividend income will naturally increase over the years. Further, by reinvesting such dividend income in other similar dividend-paying stocks, you can allow your money to grow exponentially over time. 

 

For example, say you own 1,000 shares of a company and earn Rs. 10,000 in the form of dividends (at a rate of Rs. 10 per share). You can use this to purchase more stocks in the company. Let’s say the company’s market price is Rs. 50, so you can buy 200 more shares with the dividend income, taking your total shareholding to 1,200 shares. And the next time the company declares a dividend (say at the same rate), you will earn Rs. 12,000 instead. 

 

Dividend Capture 

Dividend capture, also known as dividend harvesting, is a strategy that involves purchasing stocks of a company before the ex-dividend date and selling it on or after the said date. It is an active trading strategy that involves timing the market right and planning the entry and exit positions carefully. By employing this strategy, you hold the stocks of a company only during that fruitful phase when dividends are declared. 

 

Long-Term Dividend Investing

This is a passive dividend investing strategy where you buy stocks of dividend-paying companies and hold them over the long term. During this period, you will continue to earn dividend income from your investments. You can then reinvest this income in other market-linked products or any other asset or scheme to generate further returns from the dividend earned, thus compounding your wealth with dividends. 

 

Conclusion

All things considered, dividends are often forgotten opportunities that many stock market investors fail to take advantage of. However, now that you know all about dividend growth investing and other effective dividend investing strategies, you can tap into the power of this type of income and compound your wealth over time. 

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