After all, this seems to be the way to become wealthy over time. And if you don't believe me, take a look at this study...
The Barclays Capital Equity Gilt Study 2012 is the latest in a long series making the same point about reinvested income. It notes that:
- £100 invested in equities at the end of 1899 would be worth just £160 in real terms without the reinvestment of dividend income, but with reinvestment the portfolio would have grown to £22,239
- the effect upon a gilt portfolio is less in absolute terms, but the ratio of the reinvested to non-reinvested portfolio exceeds 400 in real terms.
To a large extent this is a result of the magic of compound interest. However, this does not mean simply buy high-yield investments. You need to keep your capital secure. As Warren Buffet's Rules 1 and 2 say: Don't Lose Money! And you can lose money on shares (and fixed-income investments) for a host of reasons. So the corollary is: look for high yield with a margin of safety. In particular, look for danger signs like poor cashflow, swelling pension deficits, falling market share, increased debts, and lack of competitiveness.
And this is the tricky part. This is why you need to spend time read, think, ponder and consider potential investments. This does require some effort, compared to letting someone else make these decisions (i.e. investing in a fund or a trust).
But the logic seems pretty convincing to me: generate income safely and reinvest it.
Update 18/11/12: For a challenging alternative view of this approach, see Retailinvestor.org.
I am not a financial adviser and the information provided does not constitute financial advice. You should always do your own research on top of what you learn here to ensure that it's right for your specific circumstances.