This simple trick can double the size of your pension pot
Whether you are a first-time investor or a seasoned pro, there are certain ways to increase the odds of investment success. One highly effective rule is to pay attention to dividends, as over the long term these are where the vast majority of the stock market's returns come from.
Those who reinvest their dividends regularly, rather than cashing in and paying themselves an income, will see a big difference in the growth of their investment pot. This is thanks to the effect of compound interest, once described by Albert Einstein as the 'eighth wonder of the world'.
Research by Fidelity Personal Investing highlights how powerful the twin phenomena of compounding and reinvestment of dividends can be. The broker looked at a hypothetical tale of two twins: 'reinvesting Roger' and 'income-drawing Iris'.
Roger started his investment plan 30 years ago at the age of 25, on 30 April 1986. He invested £100 every month into the FTSE All-Share (up until 30 April 2016).
After 30 years, Roger had invested a total of £36,000 and, because he reinvested every dividend he received, his investments are now worth a whopping £132,368.12.
His sister Iris also started her investment plan 30 years ago at the age of 25 on 30 April 1986. Like Roger she invested £100 each month into the FTSE All-Share until 30 April 2016.
But, unlike Roger, Iris chose to take and spend the income from dividends rather than reinvest it. As a result her investment is now worth just £65,723.41 - less than half of Roger's savings pot.
Tom Stevenson, investment director for Personal Investing at Fidelity International, says: "The important factor here is time. It is the key component of compounding and the reason why everyone should start to save as soon as they can.
"By adopting Roger's simple philosophy of investing regularly and reinvesting income over the long term, our figures show that you can generate some pretty spectacular returns.
"In the current "lower for longer" interest rate environment, investing in income-paying shares continues to be a very attractive option. Selectivity remains key, however, not least because dividends have been under pressure of late.
"It pays, therefore, to put your money with an experienced fund manager who has been through a few market cycles and is able to identify companies that pay not just high but also sustainable income."
This story was originally written for our sister magazine, Money Observer.
The term is interchangeable with stock exchange, and is a market that deals in securities where market forces determine the price of securities traded. Stockmarket can refer to a specific exchange in a specific country (such as the London Stock Exchange) or the combined global stockmarkets as a single entity. The first stockmarket was established in Amsterdam in 1602 and the first British stock exchange was founded in 1698.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
This is effectively paying interest on interest. Interest is calculated not only on the initial sum borrowed (principal) or saved (see APR and AER) but also on the accumulated interest. The more frequently interest is added to the principal, the faster the principal grows and the higher the compound interest will be. Compound interest differs from “simple interest” in that simple interest is calculated solely as a percentage of the principal sum.