| |
Putting Your Money to Work - The Power of Compounding
Simply put, compounding is earning a rate of return on your investments,
assuming you reinvest all earnings. Suppose, for instance, you invested
$200 and reinvested the full amount of your earnings each year.
Suppose also that your investment's return each year is 10%. Watch
what happens to your earnings:
|
Year 1: |
Original $200 investment earns $20. |
|
Year 2: |
Original $200 investment earns $20, $20 earnings from Year 1 earns $2. |
|
Year 3: |
Original $200 investment earns $20, $20 earnings from Year 1 earns $2,
$2 earnings from Year 2 earns $0.20.
|
Thanks to the power of compounding, your original $200 investment earns you $22.20 over 3 years.
The Early Starter versus The Late Bloomer
The most important lessons to glean from compounding are to start
early and reinvest your earnings. The earlier you start, the more
earnings you will realize. Compare the results of two investors
in the table below. The Early Starter invests only half as much
as the Late Bloomer but starting sooner, earns significantly more.
| Early Starter |
Late Bloomer |
| 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 |
No more contribution |
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 |
|
|
