ShareThisBy TOM RAITHEL
Scripps Howard News Service
Friday, May 11, 2007
Like your garden-variety rabbit, money has a surprising way of multiplying.
Investors who let their investment earnings compound year after year, as opposed to spending those earnings, can build a large advantage over time.
Let's say we have $1,000 to invest. That's a nice round number you can use to easily calculate what you can earn with much larger units of money.
And let's say we earn an 8 percent return on it, year after year. I know this is higher than you will get today on most interest-earning investments, such as certificates of deposit (CDs), but it's also less than the historical return of stocks. It's a reasonable number for the kind of return you might get over many years with a combination of stock and interest-earning investments.
Now let's say we have two ways to invest this money. One way is without compounding the earnings. In other words we earn our 8 percent each year on our $1,000, then we spend that 8 percent. The next year, that $1,000 earns another 8 percent and we spend it, and so on, year after year.
The second way is with compounded earnings. In other words, we keep our earnings as well as our original investment invested and let them continue to grow at 8 percent. How much difference does this compounding make over time?
At first not much. Both investments return $80 the first year. In the second year, the uncompounded investment would again return $80. The compounded investment would return that $80 plus a small difference of $6.40 This may seem like small change to you, but over time, this small change grows.
After five years, the investment that doesn't compound has earned $80 times five, or $400. The one that has compounded earnings has made $469.33, an advantage of $69.33.
Over 10 years, the compounded investment has a $358 advantage over the uncompounded one. Over 15 years, that advantage has grown to $972 or almost as much as the original $1,000 investment.
Over 20 years, the advantage is $2,060, or twice the original investment. Over 30 years, it is $6,662. Over 40, it's $17,524.
Note that I'm only talking about the advantage you earn by compounding all these years. The investor that let his money compound would also have the unspent earnings from this time, which could add up to a considerable fortune.
Also, remember what I said earlier. These examples use only $1,000. If you had $10,000 to invest, the advantage in dollars would be 10 times the above amounts. If you had $50,000, it would be 50 times the amounts.
Compounding is a big advantage. It's much more than small change.
Contact Tom Raithel at raithelt(at)courierpress.com. To comment or for more stories visit scrippsnews.com
