Compounding Interest Is King
The beauty of long-term investments is the compounding effect. Compounding allows you to generate earnings from previous earnings. This is a powerful tool as a small investment can generate huge payout over time. Below are a few examples of how understanding compounding interest can lead to huge gains.
Example 1: Set It and Forget It
- Principal (starting value invested): $10,000
- Annual growth rate: 10%
- Period of time money is left to grow: 30 years
Using the above investment parameters, you’d end up with $200,000 at the end of 30 years. Not bad for a $10,000 investment!
Example 2: Double the Principal
- Principal (starting value invested): $20,000
- Annual growth rate: 10%
- Period of time money is left to grow: 30 years
Using the above investment parameters, you’d end up with $400,000 at the end of 30 years. All we did was invest an extra $10,000 at the beginning, but we ended up gaining an extra $200,000 over our example 1 investment. That is the power of compounding interest!
Understandably, most people don’t have an extra $10,000 in the couch cushions to reinvest. The good news is, adding to your retirement incrementally will pay huge dividends.
Example 3: Incremental Investments
- Principal (starting value invested): $10,000
- Incremental additional funds invested: $500 per month
- Annual growth rate: 10%
- Period of time money is left to grow: 30 years
If you invest $10,000 into a retirement fund today that gains 10% annually and now you add $500 per month over the next 30 years, you’ll have nearly $1.35 million. By putting some money away each month towards your retirement, you can now live out your Golden Years in style!
To get a better understanding of how this works, check out this compounding interest calculator.
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