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The Eighth Wonder of the World
Compounding is sometimes referred to as the "Eighth Wonder of the World"
and is also an investors best friend. Why do people love compounding so much? Well, it's
because compounding makes many people incredibly rich!
You're probably wondering what compounding is so we'll get to the point. Compounding is
actually a very simple concept. Compounding is the idea of earning money on what you have
already earned. It may sound a little confusing but it's really not.
Here's an example: Let's say you are given $1000 by Aunt Susan for your 16th birthday.
After sending her a big thank-you card for your new wealth, you decide it's best to put
the money into a savings account that will pay you 3% interest each year. After one year,
your $1000 would have grown into $1030 (1000 x 1.03). Because you then have $1030 in the
savings account, you would make 3% on that the next year which would give you $1060.90. If
you were really patient and kept the money in for 20 years, you would have $1806.11
because the money has compounded. That's $806.11 that you have made by doing nothing but
being patient. However, if the money didn't compound, you would only have $1600, over $200
less.
That's nice but didn't you say that it could make me rich? Yes, and now that you see how
it works with a savings account, now you're ready to see the wonders that the stock market
offers. Over the years, the stock market has returned an average 13% per year so we
will use this number for the following example.
Compounding really begins to work when it comes to investing in the stock market.
Did you know that if you invested that $1000 that Aunt Susan gave you into the stock
market and kept it there for 20 years, you would have $11,523 compared to only $3600 if it
did not compound.
But compounding works the best when you start adding more time into it. Do you know how
much you would have in 50 years, about the time of retirement? More than $450,000! And
that's just with one investment! Imagine how much you would have if you added to that over
the years!
Because we are young investors, we have the advantage of time. When it comes investing for
the long-term, compounding and time go hand in hand. If you want to save $1,000,000 in 50
years, you would only have to invest $18 per month. However, if you start investing 20
years later, you would have to save $237 per month and your goals keep getting harder and
harder to reach as time goes by. So, by investing at a young age, you're giving yourself a
head start and beginning your path to becoming rich.
Next: Stock Indexes
Chris
publishes a monthly newsletter called Young Investor Monthly that helps teach and
encourage young adults to start investing. Visit the site at www.youngmonthly.com
and sign up for a free copy. |
