Compounding Interest/Compounding Value

Ahhh, the power of compounding. It makes trees stronger, rabbits more plentiful, and the rich…richer.

How so? Well, let's start with compounding's kissin' cousin, arithmetic compounding.

If you invest 1,000 bucks in a ten-year bond that pays six percent a year interest, you get 30 bucks twice a year, and then get your grand back at the end. Nice. You get the total of 1,600 bucks back from your investment, and the cash that came back to you came back in small parts along the way, until you got about ⅔ of it at the end, right?

Ok, now let's look at what 6% compounded looks like over 10 years.

Well, at the end of year one, it’s $1060, but then you essentially are reinvesting that amount, and get another 6% compounded on that $1060 instead of just the original $1000. So by the end of year two you'll have $1123.60, and by the end of year three you'll have $1,790.85.

So…why do you make so much more money when you compound interest...versus getting 30 bucks twice a year, like you would in this bond example?

Essentially, what’s happening is that you are delaying your gratification of getting cash, or getting liquid…by reinvesting your gains year after year after year. After year.

So, do you have that sort of self-control? That's the question. If you, for example, have trouble making it home from your local pizza spot with the pie intact…then compound interest might not be for you.