This simple trick can double the size of your pension pot

Compounding pigs

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'.


Compounding effects

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.

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