Albert Einstein is widely rumored to have called compound growth the most powerful force in the universe. Compounding is the ability of an asset to generate earnings not only on the initial principal but also on the accumulated interest from prior periods. In simple terms, it means generating earnings on previous earnings.
The value of an investment at any time in the future depends on three main things:
1) the dollar amount(s) you contribute;
2) the rate of return you earn;
3) the length of time you save.
Naturally, increasing any of these elements will increase the future value of your investment, but one parameter is more important than the others: time. Compound interest can significantly boost investment returns over the long term.
Years ago, Warren Buffett wrote that the Native Americans who received $24 from the sale of Manhattan Island in 1626 may have gotten the better deal. He explained that if the $24 had been invested at only 6% interest, it would have grown today to a higher value than the multi-billion dollar current real estate value of Manhattan.
The table below shows the dramatic effect of compounding on a $10,000 investment, even at relatively modest rates:
While compounding is powerful and can help produce significant wealth over time, the key to its success is to start saving early and avoid major losses along the way. Of course, you can’t go back in time to begin saving 10 years ago. What you can do is not wait another 10 years to start. Begin saving for the future right now, and let compounding work its magic for you.
All investments are subject to risk, including the possible loss of the money you invest. Past performance does not guarantee future results. There is no guarantee that any particular asset allocation, or mix of funds, or any particular mutual fund, will meet your investment objectives or provide you with a given level of income.