Growth on growth
If you earn 7% on $10,000, you have $10,700 after a year. The next year you earn 7% on $10,700, not on the original $10,000. Each year the base gets larger, so each year’s gain gets larger too. That is compounding.
The numbers
These are illustrations at a constant rate. Real returns vary year to year and are never guaranteed.
- $10,000 at 7% a year grows to about $19,700 after 10 years.
- After 20 years it is about $38,700.
- After 30 years it is about $76,100.
- The same $10,000 at 5% for 30 years is about $43,200.
Notice the shape
The last ten years in the example added far more money than the first ten, though the rate never changed. Most of the benefit comes late, which is why starting early, even with small amounts, can beat starting later with more. Adding regular contributions makes the effect stronger: $500 a month at 7% for 30 years comes to roughly $610,000 on only $180,000 of contributions, in this simplified example.
What works against compounding
- Fees: a higher yearly fee compounds against you. See expense ratios explained.
- Interruptions: selling in a panic and sitting out the recovery breaks the chain.
- Taxes and inflation: both reduce real growth, so plan with after-tax, after-inflation numbers in mind.
The takeaway
Compounding rewards patience. It is one reason many long-term investors choose low-cost diversified funds and keep investing through ups and downs.