The power of compound growthFeb 03, 2023
Compound growth refers to the exponential increase of an investment's value over time, as the gains from interest or investment income are reinvested and generate additional interest or income in the future.
So it’s when you make money, on your money, on your money.
So if you invest $100 and make 10% in the first year then that is $10 and you have $110. In the second year, if you make 10% again, well now you make $11. So the amount you make each year increases exponentially.
It starts small but really adds up over time.
The benefits of compound growth
The benefits of compound growth are huge. But most people don't realise as it takes a long time before the impact can really be seen.
The reason the benefits are huge are because the growth is exponential. It gets bigger and bigger and bigger as time goes one.
And the reason it can't be seen in the first few years is because that growth is slow. It builds up and 30 years later you might be able to live off just the growth from that year.
The exact amount of time it will take depends on what your needs are and the returns you get.
Simple interest is where you just take the interest on the original principal each year and spend it. Compound interest is where you leave the interest invested to grow.
You can use a compound interest calculator to see the impact over long periods and see the difference between simple interest and compound interest below.
How does compound interest affect debt?
Compounding cuts both ways.
It works in your favour if you are investing and getting interest on your interest. But what if you have credit card debt and you rack up $1,000 on your credit card balance?
Let's say at the end of the month, you have $25 in interest added to your credit card balance. If you don't make interest payments then you now owe $1,025.
So next month they calculate the interest you owe on $1,025 which might be $25.60.
Just like we mentioned above it starts small but it will grow fast. Especially on a big loan like your home loan.
The banks will charge you interest on your interest on your interest and over long periods you will get further and further behind.
“Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn’t ... pays it.”
~ Albert Einstein
How to take advantage of compound growth
There are two easy ways to take advantage of compound growth.
The first is to hold the investment for the long term. The growth starts slowly but after 20 to 30 years it is really amazing. So the key is to start as early as possible.
And the earliest you can start is today!
The second key is to leave your money invested to grow. Just keep buying, don't sell your investments. And reinvest all interest and dividends and watch what happens over 10 years, 20 years and 30 years.
Give your returns time to grow and in the long term you'll be exponentially better off than someone that took their returns out each year and spent them.