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The Power Of Compounding By The Numbers

In the world of finance, there is an unstoppable force that has the potential to turn small contributions into significant wealth over time – compounding interest. This powerful phenomenon has been the secret behind many financial success stories, allowing individuals to achieve exponential growth of their investments. In this blog post, we’ll delve into the concept of compounding interest and explore its incredible impact through two illustrative examples.

 

Understanding Compounding Interest

Compounding interest is not just a concept; it’s a financial superpower that works by generating earnings on both the initial principal and the accumulated interest from previous periods. In simpler terms, you earn interest not only on your original investment but also on the interest that investment has already earned. The longer your money is invested, the more significant the compounding effect becomes.  Over an extended period, the returns become exponential.

 

Example 1: The Early Bird Investor – Sarah’s Story

Let’s meet Sarah, a young professional who is concerned about her financial future. She starts contributing $500 per month to an investment account, specifically earmarked for her retirement, at the age of 25 and continues contributing until she turns 30 years old.  With this disciplined investment approach Sarah will accumulate $30,000 of total contributions to her investment account in 5 years.  In this example we are going to assume Sarah doesn’t invest a single additional dollar for the rest of her adult life, but also does not withdraw any of the invested capital until she reaches the age of 65.

 

Now, here’s where the magic happens. Assuming that Sarah is able to achieve 8% annual growth, and that growth compounds on a monthly basis, her original $30,000 investment balloons to a staggering $602,553 by the time she retires at 65. The power of compounding has multiplied her initial contributions more than 20x, emphasizing the importance of starting early and allowing time for your money to grow.

 

Example 2: The Mid-Life Investor – James’s Journey

Now, let’s explore James’s story. James decides to start investing later in life, at the age of 40. Similar to Sarah, he contributes $500 per month to his investment portfolio with the same 8% annual interest rate, for the same 5 total years. James does not contribute any additional funds until he retires at the age of 65, so his $30,000 investment only has 20 years to compound, compared to Sarah’s 35 years.

 

Despite having less time for his investment to compound, James’s patience still rewards him handsomely. His investment grows to $178,539 by the time he retires, which is almost 6x his original investment. Although James started later, the power of compounding interest proves that even those who join the game a bit later can still benefit significantly by allowing their money to compound over time.

Final Thoughts On Compound Interest

Final Thoughts on Compound Interest

Compounding interest is a financial force that rewards discipline, patience, and most importantly early action.  It delivers incredible returns when an investor invests in a financial structure that delivers a reliable compounding effect over extended periods of time. These illustrative examples showcase the transformative impact of compounding interest on wealth accumulation, and boldly highlight the exponential nature of longer hold periods. Whenever you decide to begin your investing journey, the key is to start as soon as possible and stay consistent.

The hardest part about harnessing the power of compounding is finding an investment instrument that is built to deliver this unstoppable force.  Stay tuned for our next post about where to find compounding investments.

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