I tend to keep away from actual numbers on this blog, mostly as they are not my strong suite and that I want to the readers to do their own homework.
So lets see how that goes when we will cover the subject of compounding.
IntroductionCompounding is the idea that when you receive interest on your investment and reinvest it you will start to receive interest on that interest as well. And next year, you will add another round of interest and so on. After some years, the snowball starts to build itself faster and faster.
This is the reason why you should reinvest your returns, be it interest rate or dividend payouts. The numbers go crazy after a few years.
One time investment: Savings account vs. reinvestingA very simplified scenario. Say you invest 100000. And each year, you will receive 6%. The following table shows the growth with and without reinvestment, i.e. compounding for the first 25 years. I.e. plain is your savings account with 0% interest.
The difference is a whooping 304893. Just by locking in your money and reinvesting each year the original investment has grown 4 times!
OK, the example is a little biased against the savings account. So lets look at a more realistic calculation.
Continuous investment: savings vs reinvestment strategyIn a more realistic scenario you would continue to invest new money each year, say 30000 per year the numbers would be the following:
|year||savings account + additional savings||reinvested + additional investment|
The difference now would be 1109361. That's a lot of money.
Living on the yearly returns
|savings account |
+ additional investment
+ additional investment
|10||0||30000 for 10 years||10137||30821|
|15||0||30000 for 15 years||13565||51393|
|20||0||30000 for 20 years||18154||78922|
|25||0||30000 for 25 years||24294||115762|
|30||0||30000 for 30 years||32510||165062|
After 10 years, the reinvesting plus additional investing will generate an extra investment unit of 30000 per year by itself. And after 25 years, it adds the initial investment each year!
And going from 25 to 30 years adds another ~50000 per year.
ConclusionI know my plan. Continuously invest and reinvest all dividends! Event if the 6% per year rate is just fake and in reality it would be different depending on a number of variables, taxes, costs, market fluctuations etc. But the effect of interest on interest on interest over and over again is just something that must be leveraged in any long term investment plan.
Hope this helped a little bit in showing how this effect works :)
Disclaimer. I am in no way an expert on capital management or investing. On this blog I only wish to share my findings, ideas and comments on current events and fields that interest me. I hope that my thoughts can entertain you. I expect that everyone reading take their time and do their own research before acting on anything read on this blog. Investing is not for everyone. E&OE.