Have you ever heard the phrase “making your money work for you?”
Having your money make money on its own is an attractive proposition, and it’s what compounding does for your savings and investments.
Compounding is when the earnings or interest on an asset are reinvested to generate additional earnings or interest. Basically, it’s producing interest on interest (for savings accounts) or earnings on earnings (for investments) and creating a snowball effect. Let’s say you invested $10,000 in an investment that returns 5% annually. The first year you would make $500 for a total balance of $10,500; the second year you would make $525 ($10,500 multiplied by 5%) and so on. After 30 years, the investment would be worth more than $40,000, without any additional principal contributions. Compounded earnings are based on the principal plus any cumulative income generated over previous periods, essentially creating exponential growth.
Source: Investopedia
Where Compounding is Used
Savings accounts, certificates of deposit (CDs), money markets, mutual funds, 401(k)s and IRAs, to name a few, all rely on the power of compounding to potentially create wealth for investors. As the chart above shows, compounding gains steam as time passes. Savings accounts pay compounded interest to investors while investment accounts reinvest the principal and earnings for compounded earnings.
How Compounding Affects Retirement
Because compounding is a function of time, it creates the most profit when applied over long periods, which is especially useful for retirement accounts. When it comes to retirement saving, the common advice is to start as soon as possible and that’s based on the premise that compounding has 40 years to “work its magic” and help grow investment accounts. While many young adults embarking on their career may not have much cash to spare with student loans and entry-level salaries, they do have one thing on their side – time. Because of the compounding effect, investments, even small ones, during this period may have higher growth potential and can potentially make a sizable difference in the ultimate balance of a retirement account.
For more information on which financial vehicle you may want to use to create compounded growth for your money, talk to your financial advisor.
Modiv is not responsible for third-party content.
The views and opinions expressed in this commentary reflect Modiv Inc.’s (together with its affiliates, “Modiv”) beliefs and observations in commercial real estate as of the date of publication from sources believed by Modiv to be reliable and are subject to change. Modiv undertakes no responsibility to advise you of any changes in the views expressed herein. No representations are made as to the accuracy of such observations and assumptions and there can be no assurances that actual events will not differ materially from those assumed. The forward-looking statements in this paper are based on Modiv’s current expectations, estimates, forecasts and projections, and are not guarantees of future performance. Actual results may differ materially from those expressed in these forward-looking statements, and you should not place undue reliance on any such statements. These materials are provided for informational purposes only, and under no circumstances may any information contained herein be construed as investment advice or as an offer to sell or a solicitation of an offer to buy an interest in any Modiv program or offering. Alternative investments, such as investments in real estate, can be highly illiquid, are speculative, may not be suitable for all investors, and there is no guarantee that distributions will be paid.