How Compounding Works its Magic
Einstein called compounding the eighth wonder of the world!
Compounding is often known as the magic of investing. It’s where your interest or dividends are made on both the initial principal or amount you invested as well as the earnings it’s already produced. Compounding is what makes your savings and/or investments grow at an accelerated rate, the more time, the more compounding, the more your investment is worth.
But like most things, it can work to your advantage or disadvantage. When saving or investing, it’s working to your advantage as it’s increasing in value. However, if you have borrowed money and are paying interest on that money, it also compounds meaning you will pay a lot more than what the initial cost was.
Now this isn’t always bad, it just depends on what the money was borrowed for. If it’s for investment purposes and you’ve analysed the returns and the debt makes sense then that is very different to having debt for consumption (eg a holiday, household furniture etc).
If you have $100 invested and it has a 5% dividend yield which is paid quarterly and you elect to have the dividends re-invested, at the end of the of quarter you will receive $1.25 in dividends and your total investment will be $101.25
At the end of the second quarter, your initial $100 investment plus the re-invested dividends of $1.25 will earn dividends of $1.26 and your total investment will be $102.52
At the end of the third quarter, your $102.52 will earn dividends of $1.28 and your total investment will be $103.80
At the end of the fourth quarter, your $103.80 will earn dividends of $1.30 and your total investment will be $105.10
The power of compounding means that time in the market (how long you have your funds invested) really matters. It’s by far a greater predictor of your success in investing than trying to time the market (pick the bottom and top).
Inside of Financial Freedom Fundamentals I teach my clients how to create passive income (through compounding) and increase their net worth. They not only have automated systems that work for them, they create overflow and have so much joy and happiness in their lives. All on the way to creating so much choice and freedom in their lives with abundance in all areas of their life.
