The Power of Compounding
Compounding is money multiplying itself, which allows investors to earn income on their income. Income payments grow each year because the amount upon which the payments are based also grows each year.
The following example assumes a tax-deferred investment.
If you invested $100 on the first business day of each month for 10 years at a 6% rate of return compounded monthly, you would accumulate $16,470, including your principal of $12,000. If you invested the same amount at a 10% rate of return, the total investment would be worth $20,655, a difference of $4,185.
But imagine investing that $100 over a longer period. After 20 years, your principal investment of $24,000, earning 10 per cent compounded monthly, would be worth $76,570. Your $100 a month invested over 30 years would be equal to $227,933, a substantial increase. Extend that over 40 years and your money would grow to $637,678.
Combine a higher rate of return with your regular savings and the effects of compounding are further improved.
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