The Power of Compounding
The longer you leave your money invested and the higher the interest rate, the faster it will grow. That's why stocks are the best long-term investment value. Of course, the stock market is also much more volatile than a savings account. But given enough time, the risk of losses is mitigated by the general upward momentum of the economy.
The compounding effect of investing your money is perhaps one of the most important aspects to achieving long-term wealth. For it to work, you must be a long-term investor with a lot of patience. Here is a summary of how it works.
It is important to understand that the longer you keep your investment, the more money you will make. However, the amount of money you make does not rise in a linear fashion. Instead, for each year you keep the money invested, you will earn significantly more money.
Say that you invest $1,000 and that you achieve a return of 10% per year. That means that in the first year you would have $100 in gains ($1,000 x 10%) and a total of $1,100. In the second year, you'll start with $1,100 but this year you'll earn $110 ($1,100 x 10%) for a total of $1,210. The third year you will earn $121 ($1,210 x 10%) and have a total of $1,331. You'll notice that each year you earn significantly more than the year before because each year you earn money on the previous years' gains. This is called the compounding effect of money and it is one of the most important aspects to investing and saving money.
It is important to understand that the longer you keep your investment, the more money you will make. However, the amount of money you make does not rise in a linear fashion. Instead, for each year you keep the money invested, you will earn significantly more money. This can be illustrated in the following manner:
If you earn 10% per year, at first glance, it seems like it will take you 10 years to double your money (10 x 10%)), and 20 years to triple your money (20 x 10%). However, this couldn't be further from the truth. If you keep compounding your gains and earning 10%, you will actually double your money in under 8 years, and triple your money in under 12 years. Your money will quadruple in 15 years and you will have over 6 times your investment by year 19!
To illustrate this effect, we've added a graph and table below that shows the effect of compounding your money
Total Dollars by Year, Assuming a 10% Annual Return