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.

Related or Semi-related Video

Finance: What is Compounding Value or Co...1771 Views

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Finance allah shmoop What is calm Pounding value or compounding

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interest Ah the power of compounding it makes tree's stronger

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pollution More feral and the rich Well richer How so

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Well let's start with compounds kissing cousin with six toes

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Arithmetic calm pounding Right So the first was really geometric

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compounding Now we're talking about arithmetic compounding If you invest

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a thousand bucks in a ten year bond that pay

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six percent a year in interest the dough comes back

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to you in a pattern that looks like this Like

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every six months they pay thirty bucks and it's sixty

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dollars a year Got it nice You get the total

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of sixteen hundred bucks back from your investment And the

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cash that came back to you you know came in

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small parts all along the way until you got about

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two thirds of it or sixty percent at the end

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right If you just spent that money and collected your

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thousand bucks at the end That's it Okay So that's

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arithmetic compounding the money comes to you You don't reinvest

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it Ding ding ding that's the key here and you

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just go buy burgers Okay So now let's look at

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what six percent compound id looks like over the same

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ten year period Wealth at the end of your one

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it's a thousand sixty bucks and no we're only going

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to compound it annually We probably should do the semi

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annually but we confuse you even more is we won't

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do that but then you essentially re invest that money

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and you get another six percent compounded on that thousand

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sixty instead of six percent compounded against the original thousand

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so by the end of your two you'll have a

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thousand one hundred twenty three sixty and by the end

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of your ten you'll have one thousand seven hundred ninety

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dollars and eighty five cents So why do you make

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so much more money when you compound interest versus getting

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thirty bucks twice a year like you would in this

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bond example going by and burgers with it You don't

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wanna do that well essentially what's happening is that you're

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delaying your gratification of getting that sweet sweet cash or

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getting liquid Whatever you wanna call it by reinvesting your

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gains year after year after year So do you have

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that sort of self control Do you need the cash

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Yeah that's The question If you for example have trouble

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making it home from your local pizza spot with the

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pie intact well and compound interest Keeping the discipline to

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not spend the money today and wait for the happiness

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tomorrow Well when that may not be for you Sorry

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