Dividend snowballs and DRIP: How reinvesting dividends can build your portfolio

Dividends can be a great way of supplementing your existing income, but how about using them to build your portfolio faster? Dividend growth investing is one of the strategies that a lot of investors opt for, allowing them to take advantage of a compounding effect—most often described as the dividend snowball. 

In general, stocks (usually ASX) and managed funds will offer to deposit your dividends directly into your bank account or brokerage platform cash balance. Alternatively, some will offer a DRIP option.

What is DRIP?

DRIP stands for Dividend Reinvestment Plan. It's a program offered by many companies and brokerages that allows investors to automatically reinvest their dividends into additional shares of the stock, often without any transaction fees—although keep in mind that you’ll still need to pay tax on those dividends. 

This makes the process of reinvesting dividends seamless and efficient, allowing you to take full advantage of the compounding effect without lifting a finger. 

What is a dividend snowball?

When you invest in dividend-paying stocks, you receive periodic payments from the company. Instead of cashing out these dividends, you reinvest them to purchase additional shares. Over time, the number of shares you own—and consequently, the dividends you receive—increases, creating a compounding effect that can significantly boost your portfolio's value. 

Investors generally describe this as a ‘dividend snowball’. It starts small but gathers more snow (dividends) as it descends, growing larger and larger. Of course, the difference is that it’ll ascend. Here’s a handy way of visualising this exponential growth when starting with $10,000:

• 5 years: The investment grows to approximately $16,105.
• 10 years: The investment increases to around $25,937.
• 15 years: The original investment has more than quadrupled at $41,772.
• 20 years: The investment grows to approximately $67,275.
• 25 years: The investment reaches around $108,367.
• 30 years: The investment skyrockets to about $174,494.

The magic behind the dividend snowball is the power of compounding. When you reinvest your dividends, you're essentially earning "interest on interest," or in this case, "dividends on dividends." This can have a dramatic impact on your portfolio's growth over the long term. 

For example, if you initially invest $10,000 in a dividend-paying stock with an annual yield of 4%, reinvesting those dividends could nearly double your investment in 20 years - assuming the stock's price and dividend yield remain constant. When also adding in regular contributions, the amount of growth becomes even steeper. 

Benefits of a dividend reinvestment plan

• Automated growth: With DRIP, the reinvestment is automatic, making it easier for you to stick to your investment strategy.
• No or low fees: Many DRIPs offer the option to purchase additional shares without brokerage fees, making it a cost-effective strategy.
• Dollar-cost averaging: Since you're buying shares at different price points, you benefit from dollar-cost averaging, which can reduce the impact of market volatility on your portfolio.
• Flexibility: You can start small and let the snowball effect work over time, making it an accessible strategy for investors of all levels.

Things to keep in mind

• Overexposure: Reinvesting dividends in the same stock can lead to overexposure to that particular asset. Diversification can be a helpful way of mitigating this by investing in a broad range of stocks, an ETF, or a managed fund.
• Tax Implications: Dividends are often subject to taxation, even if they're reinvested. Recording your dividends can be a helpful way of simplifying tax-time 
• Market Risks: Like any investment, dividend-paying stocks are subject to market risks. Make sure to research before committing your money.

For more information on investing, check out some of our share trading guides. If you’re looking to get started in share trading, then check out our share trading page or have a look at some of the providers in the table below.