Skip to main content

Compounding

In short

Earning returns on returns — the exponential growth of reinvested gains

If you earn 10% on $1,000, you have $1,100. Next year, you earn 10% on $1,100 = $110. Over 30 years, $1,000 becomes $17,449. Einstein called compounding the 'eighth wonder of the world.' Time is your greatest advantage.

Compounding generates exponential growth by reinvesting returns to generate further returns. The Rule of 72 approximates years to double: 72 ÷ annual return. Starting early matters enormously — $10,000 invested at 25 is worth 4× more at retirement than the same invested at 45.

Formula

FV = PV × (1 + r)^n

Related concepts

  • Dollar-Cost Averaging — Instead of trying to pick the perfect time to invest, invest $200 every month regardless of price. When prices are low, you buy more shares. When high, you buy fewer. Over time, this averages out your cost and removes timing anxiety.
  • Time Horizon — Investing for 30 years? You can weather market crashes because you have time to recover. Investing for 3 years? You need safer investments because a crash could derail your goals. Time horizon is the single biggest factor in portfolio design.
  • Dividend Yield — If a stock trades at $100 and pays $3 a year in dividends, the yield is 3% — similar to the interest rate on a savings account, but for a stock. Because yield is dividends divided by price, it also rises whenever the stock price falls, even if the dividend itself hasn't grown at all.
  • Index Fund — An index fund automatically owns every stock in an index (like the S&P 500). No stock picking. Very low fees. You get the market's return. Studies show 80-90% of active fund managers underperform index funds over 15 years.