Compounding occurs when an investment generates earnings (also referred to as returns) and those earnings are reinvested, which generates even more earnings of their own. Many online investment calculators can help illustrate the power of compounding but to gain a better understanding of the benefits compounding offers, consider the following scenario:
You begin investing on the day you turn 20 years old. (Congratulations and Happy Birthday!)
You begin with an initial investment of $1,000 and make sure to contribute an additional $100 every month.
If you do the math, by the time you reach the age of 60 (Happy Birthday again!), you will have invested a total of $49,000. Not bad, right?
Except, because all of the earnings on your investments have been compounded for the past forty years, actual your investment balance would be worth more than $200,000 (assuming a modest 6% rate of return). Now that is something to celebrate!
Remember, even small contributions to an investment account will build over time. The important thing is to start as early as possible and make investing a life-long habit by allocating a specific amount to your retirement savings every month as part of your budget. Your future self will thank you.
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