Make Compounding Work for You

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Make Compounding Work for You

The concept of compound interest can be applied through various methods.

Taking advantage of compound interest need not be a passive strategy on your part. The bigger your investment base, the more that time and math will conspire to build up your wealth. That is why investment advisors suggest taking advantage of time and a schedule of periodic investing. The results build on themselves.

Things To Know

  • Investing early can help maximize the effects of compounding.
  • Adding to an investment builds upon its base.
  • Reinvesting dividends builds your investment base.

You can consider applying some of these active strategies by following a few easy steps:

Invest early

The longer your money has time to work for you, the more significant the effect of compounding can be. In fact, the effect is far more dramatic the earlier you begin and the longer you stay invested. So, the sooner you can begin investing, the more interest or dividends, and hence growth of your principal, can begin compounding your earnings earlier.

Invest often

Even though periodic or systematic investing does not assure a profit or protect against loss, adding to your investments on a regular basis such as monthly or weekly can help build your wealth quickly. The accumulation builds the base on which your interest is calculated. To stay on a schedule for periodic investing, some people take part in automatic investment plans, in which money is taken out of their deposit accounts and put into their chosen investments.

Reinvest your dividends

If you own shares in a stock or mutual fund, you may be able to reinvest your dividends into more shares. This continues to build your investment base, allowing you to compound your return. It’s putting your new income to work for you. The same logic should apply to credit unions who also refer to earnings as dividends.

An example

The example below shows the power of compounding, using a 6% rate, which is not typical in all time periods or all investments. Note that as the years increase, the curve gets steeper and steeper. This pattern attests to the way that compounding builds on itself to raise the speed at which your wealth accumulates.

Compound Interest over Time