One of the biggest debates among ASX investors is whether to focus on dividends or growth in your ASX portfolio.
Financial theory tells us that if a company is paying out more of its cash to shareholders in the form of dividends, that leaves less money available to invest in value-add projects to increase firm value.
This is why free cash flow is such a commonly used metric in company valuation, because it tells investors how much money is left over for shareholders after all company expenditure has been accounted for.
The good news is, with the use of dividend reinvestment plans (DRPs), you can easily make your ASX dividend stocks your best weapon in building your wealth quickly through investing.
How can I reinvest my dividends?
This really comes down to the individual company, but many of the top ASX dividend stocks will have a dividend reinvestment plan in place for shareholders.
In this day and age, often you can simply log in to your share registries such as Link Administration Holdings Ltd (ASX: LNK) or Computershare Ltd (ASX: CPU) and click through the options to elect to reinvest your dividends.
That means when you collect your 5.5% dividend from the likes of BHP Group Ltd (ASX: BHP), you can be purchasing more shares with those dividends rather than getting cash into your bank account.
While this might represent a short-term sacrifice, the long-term benefits of reinvesting dividends can far outweigh the lost cash income in the meantime.
Even better, there are certain companies such as Woolworths Ltd (ASX: WOW) which offer DRPs at a discount from time to time, meaning you can reinvest your dividends and receive more shares at a discount to market value.
But, how does this make me an ASX millionaire?
While all of this might seem complex and a little daunting, the maths behind reinvesting dividends in the long-term really does stack up.
As an example, a quick calculation of the S&P/ASX 200 Index (INDEXASX: XJO) shows that it has climbed 25.2% higher in the last 5 years – a tidy return, if unspectacular.
However, if we look at the S&P/ASX 200 Net Total Return Index (INDEXASX: XNT), which includes dividends reinvested on the ex-dividend date, the index’s performance is nearly twice as good as that of the pure capital gains.
The Net Total Return Index is currently at 66,311.50 points, up from 43,148.20 in October 2014, representing a 53.7% return on investment in 5 years.
While this calculation works for the index, you can test it for yourself with a number of blue-chip dividend stocks such as BHP or Woolworths over any given timeframe.
By extrapolating this calculation out on a $100,000 or $500,000 ASX share portfolio, it’s easy to see how you can quickly become an ASX millionaire with a click of a button and a touch of luck over the coming years.
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Kenneth Hall has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Link Administration Holdings Ltd. The Motley Fool Australia has recommended Computershare and Link Administration Holdings Ltd. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.
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