COMPOUNDING... THE 8TH WONDER OF THE WORLD

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We naturally think in straight lines and linearity when it comes to our money.  

We see our checking account balance grow with each deposit and fall with each expense. 

Many of us see our retirement accounts the same way. We only count on our contributions to grow the account. However, depending on what the account is invested in, you won’t only see your balance fluctuate with contributions, you will also see it change with the market.

When compounding takes over your money, get ready. You are in for a ride. 

Compounding happens when you start earning a return, not only on the money you invested, but also on the prior year’s returns.  Look at this chart below.

This chart is an example of compounding versus linearity. 

In both accounts you are contributing $500 a month or $6K a year. 

If you’re depositing this into a checking account that makes no interest or putting it under your mattress, the orange line will be the result. At the end of 40 years, you would have $240K ($6K x 40 years). 

If you took the same $500 every month and contributed it to an account that averaged an 8% return, then you would end up with almost $1.6M, eight times the amount of the orange line. 

You can see the first few years don’t make much difference between putting the $500 under your mattress or into an investment account, but as time passes and compounding takes effect, the results speak for themselves.

The power of compounding is amazing. 

Now, the question you should be asking yourself is, how do I take advantage of this in my life? That’s the right question. 

How do you get in a position to make compounding work for you?