Over time, compounding investment earnings can really help to super-size even the smallest investments. In a nutshell, the money you invest earns interest and you begin to earn interest on the money that you originally invested, in addition to the interest you've accumulated.
Here how it works. Let's assume you invest $1,000 at one time and get 6 percent interest each year. At the end of the first year your $1,000 investment will be worth $1,060.
However the magic doesn't begin until the next year. Rather than just getting $60 in interest, you will get $63.60 (6 percent of $1,060). As time goes on, the interest amount gets larger and larger. Over 30 years, the interest will total $5,743. That's a lot more than the $60 a year ($1,800) that you would have built up without compounding. That's the magic of it!
The Magic of Compounding depends on three primary factors:
- How much money you invest;
- How much time your investment spends growing;
- The investment growth or interest rate.
For example, the chart below shows how a $1,000 investment compounded at various rates of return will grow over time.
Compounding really begins to kick in when you begin to make more than one deposit to your account and reinvest the interest. This is when the power of compounding really begins to work. As you begin to effectively manage your investments and diversify your portfolio, it's not unrealistic to see returns of greater than 10 percent compounded.
Magic of Compounding
|
Years
|
4%
|
6%
|
8%
|
10%
|
|
10
|
$1,481
|
$1,791
|
$2,159
|
$2,994
|
|
20
|
$2,191
|
$3,207
|
$4,661
|
$6,728
|
|
30
|
$3,243
|
$5,743
|
$10,063
|
$17,449
|