Why dividends will make you a millionaire

Investing for the future is all about trying to achieve the best returns for your money.

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How you go about investing your cash depends on your circumstances. If you are at the beginning of your savings career, you might favour a higher risk, higher reward strategy, which is generally considered unsuitable for those nearing retirement.

However, whichever strategy you choose, it is likely dividends will be a fundamental part of your savings play. And if they are not, they should be.

The most important tool

Dividends are the single most valuable tool available to investors for wealth creation over the long term. Dividends can quite literally make or break your investment performance and without them you stand almost no chance of being able to match or beat market returns.

Many different studies support this statement.

The most comprehensive one is from the highly informative "Triumph of the Optimists: 101 Years of Global Investment Returns," by Elroy Dimson, Paul Marsh and Mike Staunton.

Published more than a decade ago now, this book is relatively old, but the figures are by no means out of date. Indeed, while the book is more than ten years' old, the data contained within its pages goes back to 1900. It's difficult to argue with such a long-term data set.

The authors found that between 1900 and the year 2000, one dollar invested in US equities would have grown to $198 in nominal terms, a gain of 5.4% excluding reinvest dividends. If dividends were reinvested over this period by the end of the study the investor would be sitting on a total portfolio worth $16,797, a portfolio 85 times larger than that of the capital-gains-only investor.

The total return achieved over the period with dividends reinvested is 10.1% per annum.

Critical lesson

Even though the data is taken from the US equity markets, the conclusion is the same, dividends are key to long-term wealth creation. This study also shows how much additional wealth can be created if your annual return is doubled thanks to the benefits of compounding.

Some simple back-of-the-envelope maths shows just how helpful dividends can be in helping you reach that key £1m target.

If you start off with £1,000 and add £100 per month, with capital growth alone of 5.4% per annum (based on the figures above) it would take 71 years to hit the magical £1m. However, including dividends, and once again using the return figures above, at a growth rate of 10.1% per annum, the same principal and monthly additions would require only 44 years to hit £1m.

These figures may not be 100% accurate, but that shouldn't detract from the main takeaway that dividends are vital if you want to build a retirement nest egg. Without these regular payouts, investing for the future would be a different game altogether.

Make money, not mistakes

The figures above show how important it is for dividends to feature in your portfolio, but most investors apparently ignore these figures.

Indeed, a recent study conducted by financial research firm DALBAR found that the average investor realised an annual return of only 3.7% a year over the past three decades, underperforming the wider market by around 5.3% annually thanks to poor investment decisions such as ignoring the benefits of dividends.

To help you streamline your investment process, realise and understand the most common investor mis-steps, the Motley Fool has put together this new free report entitled The Worst Mistakes Investors Make.

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Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.