The Power of Compounding


If someone offered you a million dollars today, or a penny doubled every day for a month, which would you choose?

If you think it’s a trick question, you’re right. You’d be a fool to take the million dollars, because a penny doubled every day for 30 days becomes $10,737,418.24. What the #$@&%*!?

Yup, you read that correctly — over ten million dollars. In the spirit of financial literacy month, let’s review the principle that has the power to turn a penny compounding at 100% daily return into $10,737,418.24 in just 30 days.

Here’s how it works:
Imagine you invested $100, and your hypothetical investment averaged a 10% annual return.

After the first year, your $100 would earn 10%, or $10. So, you’d have $100 + $10, or $110.

In your second year, you’d start with $110, and earn 10% of that, or $11. So you’d have $110 + $11, or $121.

In your third year, you’d start with $121, and earn 10% of that, or $12.10. So you’d have $121 + $12.10, or $133.10

In your fourth year, you’d start with $133.10, and earn 10% of that, or $13.31. So you’d have $133.10 + $13.31, or $146.41

If you held your investment for 20 years with the same average annual return, your initial investment of $100 would be worth $672.75. That’s some hard working money!

It’s called compounding. It may seem like magic, but it’s really math. Einstein supposedly called compounding ‘the most powerful force in the universe.’

The secret behind the math is that your earnings, no matter how small in the beginning, have the potential to make earnings, too. And over time, they can really add up.

What does compounding mean for you?
1. It doesn’t matter how much you start with– you just have to start. The beauty of compounding is that you don’t need a lot of money to unlock the benefits. Compounding works with a penny, $5, or $1 million. So invest what you can afford, on a regular basis, and let compounding work for you.

2. It’s all about the dividends. When companies make a profit, they sometimes share those profits with their investors. They’re called dividends, and you should get to know them better. If you reinvest those dividends, that money is affected by compounding, too. In the long run, that money has the potential to earn you more. Money that earns money, that earns money? Sounds like a pretty sweet deal to me.

3. Stay in this for the long term. It should come as no surprise that the magical component of this mathematical formula is time. As a young investor, time is on your side. In order to reap the benefits of compounding, start now and let that time work in your favor.

Which brings us back to number 1 — it doesn’t matter how much you start with — you just have to start.


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