Oh, the joys of compounding.
We often hear financial experts say that, if only workers in their 20s would save just $880 a month, they would have a million dollars by the time they retire at age 60, with a constant return of at least 5%. A 45-year-old would have to invest $3,741 a month to save the million dollars by age 60, almost four times as much. So, thanks to compounding, instead of buying that fancy new car or taking an expensive vacation, it pays to put money away for retirement. And keep it there.
In order for compounding to work, one has to reinvest the earnings on an asset. Rather than taking out the dividends you earn on a stock, or the interest earned in a savings account or CD, smart investors reinvest dividends to buy more shares, and the interest on a savings account becomes part of the ever-growing principal.
Richard invests $10,000 in an index fund called Grow Your Money Fast and holds it for 20 years. Since he reinvested all dividends, interest, and capital gains back into the fund, it is now worth $45,000. If he hadn’t reinvested the distributions, the value of his investment would only have been about $30,000. Since Richard held this fund in his retirement account, the savings will grow tax deferred as well.
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Finance: What is Compounding Value or Co...1771 Views
Finance allah shmoop What is calm Pounding value or compounding
interest Ah the power of compounding it makes tree's stronger
pollution More feral and the rich Well richer How so
Well let's start with compounds kissing cousin with six toes
Arithmetic calm pounding Right So the first was really geometric
compounding Now we're talking about arithmetic compounding If you invest
a thousand bucks in a ten year bond that pay
six percent a year in interest the dough comes back
to you in a pattern that looks like this Like
every six months they pay thirty bucks and it's sixty
dollars a year Got it nice You get the total
of sixteen hundred bucks back from your investment And the
cash that came back to you you know came in
small parts all along the way until you got about
two thirds of it or sixty percent at the end
right If you just spent that money and collected your
thousand bucks at the end That's it Okay So that's
arithmetic compounding the money comes to you You don't reinvest
it Ding ding ding that's the key here and you
just go buy burgers Okay So now let's look at
what six percent compound id looks like over the same
ten year period Wealth at the end of your one
it's a thousand sixty bucks and no we're only going
to compound it annually We probably should do the semi
annually but we confuse you even more is we won't
do that but then you essentially re invest that money
and you get another six percent compounded on that thousand
sixty instead of six percent compounded against the original thousand
so by the end of your two you'll have a
thousand one hundred twenty three sixty and by the end
of your ten you'll have one thousand seven hundred ninety
dollars and eighty five cents So why do you make
so much more money when you compound interest versus getting
thirty bucks twice a year like you would in this
bond example going by and burgers with it You don't
wanna do that well essentially what's happening is that you're
delaying your gratification of getting that sweet sweet cash or
getting liquid Whatever you wanna call it by reinvesting your
gains year after year after year So do you have
that sort of self control Do you need the cash
Yeah that's The question If you for example have trouble
making it home from your local pizza spot with the
pie intact well and compound interest Keeping the discipline to
not spend the money today and wait for the happiness
tomorrow Well when that may not be for you Sorry
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The IRS taxes bondholders imputed interest based on whatever interest rate is imputed, or presumed, by the terms of the deal.