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Here’s my dividend strategy for beating the State Pension

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According to a study by Barclays, if you’d invested £100 in the UK stock market in 1945, and reinvested all your dividends, you’d have a stunning £180,000, even after inflation. That’s the power of dividends.

But how do you actually go about re-investing dividends, which will often be relatively small amounts?

Scrip

A friend of mine has some shares in an employee-based scheme, and he takes his dividends as scrip — so instead of cash, he gets the equivalent in new shares. If it’s a fractional number, the remainder is held and combined with the next dividend.

That’s a cost-effective way to reinvest, as there are no charges to pay, so even very small amounts can be taken in shares. A typical broker’s fee could be a big percentage of a small dividend sum.

Unfortunately, the scrip route is closed to many of us who use nominee stock broker accounts. Many (including mine) don’t provide the option of taking scrip dividends — and a lot of companies don’t offer scrip anyway.

DIY

So we have to take our dividends as cash and then buy more shares ourselves. That raises a number of questions, most importantly how much to accumulate before it becomes cost effective to reinvest it?

As an example, last month, one of my investments paid me a dividend of £55.60. My broker charges a flat £10 for a share purchase, so I’d never invest such a small sum as I’d instantly be down 18% just from the transaction cost.

So I let my dividend cash build up until a £10 charge accounts for a sufficiently small percentage as not make much of a dent in it. Only then do I buy new shares. But what’s a sensible minimum?

Cheap dealing

I see around £1,000 as a good sum, meaning the dealing charge amounts to a modest 1%, which I reckon is well worth paying. Some people will be happy with less than that, and even as little as £500 would leave me with a 2% charge — I could live with that if I saw an unmissable purchase. So somewhere between those limits will typically be my minimum.

And some accounts even offer charges so low that you could get away with purchases of around £200. But they pool investors’ cash and typically only deal on a couple of days each month.

What to buy?

Then what to buy? More of the same shares, or a new stock altogether?

Reinvesting in the same shares might seem to be the obvious way to maximise the return from a specific investment. But if you’ve pooled dividends from a number of stocks, it might not be obvious which to go for — perhaps each in rotation every time you have a new investment allocation.

Consistent strategy

But my dividend reinvestment purchases always follow the same criteria as any new money in my pension or ISA, and I stick with my usual strategy regardless of the source of the cash.

My most recent example is an investment in Sirius Minerals, which was top of my shortlist after one of its regular price dips, just as a dividend came in, and took my cash to a cost-effective amount.

What you buy is up to you, but it does seem clear that reinvesting dividend brings in the best rewards.

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Alan Oscroft owns shares of Sirius Minerals. The Motley Fool UK has recommended Barclays. 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.