Starting out
Compounding
Earning returns on the returns you already earned, so growth accelerates the longer you leave it alone.
How it works
Compounding is the reason time is the most powerful variable in investing. Money that grows at 7% a year does not grow by 70% in ten years; it roughly doubles, because each year starts from a larger base than the last.
The effect is unremarkable early and dramatic late. Most of the total growth in a long investment arrives in the final third of the period, which is precisely the stretch that people who start and stop never reach.
Where it misleads people
Compounding works identically on costs. A 1% annual fee does not cost you 1%; over thirty years it quietly removes roughly a quarter of the final amount, because every pound taken out is also a pound that never compounds.
Formula
Final value = starting value × (1 + r)^n, where r is the yearly return and n the number of yearsWorked example
$10,000 at 7% a year becomes about $19,700 after 10 years, $38,700 after 20, and $76,100 after 30. The third decade adds more than the first two together.
Related terms
- CAGRThe steady yearly rate that would have turned your starting value into your ending value.
- Expense ratioThe annual percentage of your money a fund takes to cover its running costs.
- Total returnThe full return from an investment: price change plus every dividend or interest payment received.
- Time horizonHow long until you need the money — the single fact that should shape most of your other decisions.
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Educational reference only. Nothing here is investment advice or a recommendation to buy or sell anything, and tax treatment depends on your own circumstances and the country you are in.