Compounding helps money grow more quickly

By Kenneth Wallace
GuideStone Capital Management

Famed 20th-century physicist Albert Einstein is reported to have said, “The most powerful principle I ever witnessed was compound interest.”

Compounding is a pretty simple concept; it’s the return on the original investment, plus the return on the previous earnings.

How big is it? Consider the following: To accumulate $100,000 by age 65, with 8 percent annual earnings:

• a 30 year old would need to make a $44 monthly contribution.
• a 40 year old would need to make contributions of $105 a month.
• a 50 year old would need to make contributions of $290 a month.

What’s the total, out of pocket, using the above example?

For the 30 year old, $18,480; the 40 year old, $31,500; the 50 year old, $52,200.

All of them, through the returns on their investments, would net $100,000 at age 65.

How does it work? Let’s say you have $1,000 to invest and can earn a consistent 10 percent return. You don’t contribute another dollar to your account.

At the end of the first year, you’ll have $1,100 in your account — your initial $1,000 plus $100 in interest. Over the next few years, you will receive the following:

• year 2: $1,210 — $1,100 from year 1, plus $110 in interest.
• year 3: $1,331 — $1,210 from year 2, plus $121 in interest.
• year 4: $1,464 — $1,331 from year 3, plus $133 in interest.
• year 5: $1,610 — $1,464 from year 4, plus $146 in interest.
• year 6: $1,771 — $1,610 from year 5, plus $161 in interest.
• year 7: $1,948 — $1,771 from year 6, plus $177 in interest.
• year 8: $2,143 — $1,948 from year 7, plus $195 in interest.

In reality, investment fund returns do vary year to year and there may be losses during certain years, but the point still remains the same. Over time, your money has the potential to grow.

In the above hypothetical example, consider the gains that could have happened had you continued adding money to the account, rather than just watching the gains on the initial investment.

Compounding is a simple way to help your money grow more quickly. The key is to get started as soon as possible — even today — so that compounding can start working for you.

EDITOR’S NOTE — Kenneth Wallace, chartered financial analyst, is the client service manager for GuideStone Capital Management, a registered investment adviser and a controlled affiliate of GuideStone Financial Resources of the Southern Baptist Convention.