|
Compounding Effect
The 8th wonder of the world is the compounding effect of money. This is often overlooked or underestimated by people when making financial and lifestyle decisions.
While many people do not understand the compounding effect of money, it is a main driver of long-term financial success.
Compounding is where you reinvest the money you make from interest or dividends back into the capital and continue to reinvest the capital as it grows.
In effect, you receive interest on the interest that you have reinvested. |
Compounding
Effect
Calculator
The compounding interest calculator can show you how much you will need to save for retirement or any other purpose. |
|
The Compounding Interest Formula
Now you have to admit there is something mystical about getting money for nothing or earning interest on interest.
Below is the formula for calculating compounding interest.
Future Value = Starting Value (1 + interest)n
Say you put $10,000 into a five year term deposit earning an annual interest rate of 7.5%. Your starting value is $10,000, the interest rate is 7.5% and “n” is the number of years that you hold the investment.
Future Value = $10,000 (1+7.5%)5
Which equals a future value of $14,356.30
|
To illustrate the compounding effect of money, let’s look at some financial examples.
Capital – Reinvesting the Interest
If you invest $5,000 at 5% pa you will receive $250.00 interest. If you reinvest $5,250 in year 2 you will receive $262.50 interest. If the interest you earn is reinvested each year, after 10 years you will have $8,144 and after 20 years you would have $13,266.
The effect of compounding of money on an initial investment of $5,000, $10,000 and $20,000 can be seen here:
Table showing the effect of compounding>>> |
|
Capital - Further Investments Each Month and Reinvesting the Interest
Even more powerful than re-investing the interest with the capital is to invest an extra amount to your capital each month.
This is where the effect of compounding really comes into play.
For example if you were to invest an additional $100 each month, together with compounding interest you would achieve the following:
Table showing additional $100 each month, together with compounding interest >>>.
|
|
 |
| Money Tree |
|
|
|
|
