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| The Power of Compounding?
Compounding means you earn money on the money your investments make. If you invest in a product that has regular interest, like a Certificate of Deposit (CD), you only receive interest on your original investment. When you invest in mutual funds or similar investments that have growth potential, as an increase in the investment value occurs, it compounds at a faster rate because you earn money on principal as well as the growth that was earned earlier.
Say you invested $1,000 and it pays 5% regular interest each year – you would get $50 each year. Now consider a mutual fund investment where you invested the same amount and earned the same 5% annual return for the same number of years. Since the investment earnings are compounded and you make money on the money your investment earned earlier, your investment value is greater every year than it would be had the interest not been compounded. As the chart illustrates, the power of compounding adds up over time.
5% Regular Interest
5% Compounded Earnings
Initial Investment
$1,000
$1,000
End of Year 5
$1,250
$1,276
End of Year 10
$1,500
$1,629
End of Year 15
$1,750
$2,079
End of Year 20
$2,000
$2,653
End of Year 25
$2,250
$3,386 |
