Compounding
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Compounding happens when the earnings on your investment start generating earnings of their own. As the
effects of compounding snowball over time, the growth of your money is accelerated.
Here’s how it works:
- You make an initial investment.
- Your investment generates earnings, which you reinvest.
- The new, higher investment total (your initial investment plus the earnings) generates higher earnings.
You reinvest those earnings too.
- Each period, the growing investment total generates growing amounts of earnings.
- Over time, this can make a huge difference in how much you accumulate. That’s because the money keeps
growing and compounding on its own — even if you never make additional investments after the first one.
And the earlier you start, the better. Here’s the proof:
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Two investors: Judy and Joe, both age 60
At age 21, Judy invested $10,000.
The money earned an average total return of 8% a year.
At age 31, Joe made his first investment, for $10,000.
It too earned an average total return of 8% a year.
Now, at age 60, Judy has $201,153 while Joe’s total is $93,173.
Why such a big difference, when they each started with a single $10,000 investment?
Ten extra years of compounding, adding up to $107,980!