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Compounding

"What do you consider the greatest invention of all time?" - Reporter
"Compound interest." - Albert Einstein

Many novice investors have a hard time grasping the concept of compounded earnings. So think of it this way: You know that $500 you charged on your credit card a few years ago and never paid off? Funny how that balance has grown to over $3,500 even though you pay the minimum each month and have sworn off any further purchases.

That's how investing works, only you could've earned that $3,500 if you had invested the money instead of spending it on clothes and a new CD player.

Generation X versus The Baby Boomer
The most important aspect of compounding is to start early. The younger you start, the more you'll earn. See how this works in the table below, where one investor who starts younger but invests less money over less time actually ends up earning more.

Generation X

Baby Boomer

Age

Contribution

Age

Contribution

25

$2,000

25

None

26

$2,000

26

None

27

$2,000

27

None

28

$2,000

28

None

29

$2,000

29

None

30

$2,000

30

None

31

$2,000

31

None

32

$2,000

32

None

33

$2,000

33

None

34

$2,000

34

None

35

35

$2,000

36

 

36

$2,000

37

 

37

$2,000

38

 

38

$2,000

39

 

39

$2,000

40

 

40

$2,000

41

 

41

$2,000

42

 

42

$2,000

43

 

43

$2,000

44

 

44

$2,000

45

 

45

$2,000

46

 

46

$2,000

47

 

47

$2,000

48

 

48

$2,000

49

 

49

$2,000

50

 

50

$2,000

51

 

51

$2,000

52

 

52

$2,000

53

 

53

$2,000

54

 

54

$2,000

Total
Contribution

$20,000

Total
Contribution

$40,000

Total
Earnings
at 8%

$135,042

Total
Earnings
at 8%

$91,524


 Inflation

 Compounding

 

 Dollar Cost Averaging

 

 

 

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