Compounding Growth

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• Introduction to compounding growth
• An example of how compounding growth works

An example of how compounding growth works

You invest $1000 for one year at 6%. At the end of the year, you get back your $1000 and you receive $60 interest.

Because this is part of your savings and investment plan, you reinvest the $1000 again the following year at 6%. But, you can now also invest the $60 interest, for one year at 6%.

At the end of year two, you get back $1000 plus $60 interest. But you also get back the first year's $60 interest, as well as the interest on that, of $3.60.

The compounding effect is that you've earned $3.60 interest on your interest. That's additional to the interest on your original $1000. It might not sound like much right now, but multiply that over the next 20 years and you can see why some people (including the Shape of Money) get excited about the concept, and why they tell you to start saving early.

The $1000 invested every year at 6% would generate $60 interest each year for a total of $1200 interest over that 20 year period.

But, if you reinvest the $60 interest each year to take advantage of the compounding growth effect, you'll get back a total of $3,207. At the end of the 20 years, you get your original $1,000 back, plus the $1,200 interest, plus an extra $1,007, which is the interest on the interest.

To get that extra $1,007, you didn't have to save any harder, you just reinvested the interest income. Money for jam, as they say.

What we've done is to create a compounding growth calculator that you can use to run your own calculations. Put some numbers in and have a go.