How Compounding Works

Saving doesn't create much of a return.

Without earning a return, you can't take advantage of compounding.

Investing creates a return for your money, which allows compounding to work.

Compounding is the magic that happens when you start earning a return, not only on your contributions, but also on your prior year returns.

If you invest $1,000 a year, and earn 10%.

In year 1, you would earn $100.

In year 2, you would earn $110 (not $100), because you earn 10% on $1,100.

Compounding really does wonders when you give it time and consistent contributions.

Look at this example:

This assumes a $500 per month contribution over 40 years.

The orange line assumes no return.

The grey line assumes an 8% return.

Without compounding, you'd have $240K.

With compounding, you'd have $1.6M.