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The Compounding Effect of Investing
The compounding effect of investing your money is perhaps one of the most
important aspects to achieving long-term wealth. For it to work, you must
be a long-term investor with a lot of patience. Here is a summary of how
it works.Say that you invest $1,000 and that you achieve a return of 10% per
year. That means that in the first year you would have $100 in gains
($1,000 x 10%) and a total of $1,100. In the second year, you'll start
with $1,100 but this year you'll earn $110 ($1,100 x 10%) for a total of $1,210.
The third year you will earn $121 ($1,210 x 10%) and have a total of $1,331.
You'll notice that each year you earn significantly more than the year before
because each year you earn money on the previous years' gains. This is
called the compounding effect of money and it is one of the most important
aspects to investing and saving money.
It is important to understand that the longer you keep your investment, the
more money you will make. However, the amount of money you make does not
rise in a linear fashion. Instead, for each year you keep the money
invested, you will earn significantly more money. This can be illustrated
in the following manner:
If you earn 10% per year, at first glance, it seems like it will take you 10
years to double your money (10 x 10%)), and 20 years to triple your money (20 x
10%). However, this couldn't be further from the truth. If you keep
compounding your gains and earning 10%, you will actually double your money in
under 8 years, and triple your money in under 12 years. Your money will
quadruple in 15 years and you will have over 6 times your investment by year 19!
To illustrate this effect, we've added a graph and table below that shows the
effect of compounding your investments:
Total Dollars by Year, Assuming a
10% Annual Return
Total Dollars Invested and Profit Per Year, Assuming $1,000
Initial Investment and a 10% Annual Return
|
Year |
Total $ |
Profit $ |
|
Year |
Total $ |
Profit $ |
|
0 |
$1,000 |
$100 |
|
21 |
$7,400 |
$740 |
|
1 |
$1,100 |
$110 |
|
22 |
$8,140 |
$814 |
|
2 |
$1,210 |
$121 |
|
23 |
$8,954 |
$895 |
|
3 |
$1,331 |
$133 |
|
24 |
$9,850 |
$985 |
|
4 |
$1,464 |
$146 |
|
25 |
$10,835 |
$1,083 |
|
5 |
$1,611 |
$161 |
|
26 |
$11,918 |
$1,192 |
|
6 |
$1,772 |
$177 |
|
27 |
$13,110 |
$1,311 |
|
7 |
$1,949 |
$195 |
|
28 |
$14,421 |
$1,442 |
|
8 |
$2,144 |
$214 |
|
29 |
$15,863 |
$1,586 |
|
9 |
$2,358 |
$236 |
|
30 |
$17,449 |
$1,745 |
|
10 |
$2,594 |
$259 |
|
31 |
$19,194 |
$1,919 |
|
11 |
$2,853 |
$285 |
|
32 |
$21,114 |
$2,111 |
|
12 |
$3,138 |
$314 |
|
33 |
$23,225 |
$2,323 |
|
13 |
$3,452 |
$345 |
|
34 |
$25,548 |
$2,555 |
|
14 |
$3,797 |
$380 |
|
35 |
$28,102 |
$2,810 |
|
15 |
$4,177 |
$418 |
|
36 |
$30,913 |
$3,091 |
|
16 |
$4,595 |
$459 |
|
37 |
$34,004 |
$3,400 |
|
17 |
$5,054 |
$505 |
|
38 |
$37,404 |
$3,740 |
|
18 |
$5,560 |
$556 |
|
39 |
$41,145 |
$4,114 |
|
19 |
$6,116 |
$612 |
|
40 |
$45,259 |
$4,526 |
|
20 |
$6,727 |
$673 |
|
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