What Is Compounding?

Learn about compounding in this Howcast finance video with expert Gregory McGraime.

Transcript

You've probably heard of compounding before, but compounding really means you are earning interest on the interest of an investment. And what's really important about this is that it helps you grow your money a lot faster, because you have the power of compounding working in your favor. So let me give you an example. You know, if I invest $100 and the first year I'm investing I earn 10% that means I earned $10 and now I have $110. But that next year I can earn interest on the original $100 and the $10 as well, and that's really what compounding means. And compounding really helps you accelerate the growth of your money; particularly you're investing for longer periods of time. When it comes to compounding you need to invest as early as possible because the number one thing that's on your side when it comes to compounding is time. The longer the time you have the further you can grow your money. Compounding also works in the other direction. If I owe money and I have a lot of debt and I'm paying interest, interest is accumulating and I may owe interest on that interest. So compounding can work in a negative fashion as well when I' dealing with consumer debt for example. So what do you want to do? Start saving and investing as soon as you possibly can. The earlier that you can start saving for a goal like retirement the better, uh, pay down debt sooner rather than later for the same reason. A lot of times people think that small differences, really won't add up and I hear this all the time. You know "I can't really save for my future today but next year I'll get around to it." And the next thing you know 7 or 8 years go by and the person haven't started saving for retirement and they're missing out on that that power of compounding. And it really becomes harder to catch up. If there is one thing I want you to walk away from this section on compounding with, start today whatever it is, as it relates to your financial situation that you are trying to do, weather its saving for retirement or trying to pay down debt, doing it today allows compounding to work for you and make sure that time is on your side.

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