![]() ![]() The market has recorded average annual returns of 9.5% since the S&P 500 was started nearly 100 years ago. Just remember that 6% annual returns is a conservative estimate. In 10 years, with markets growing at the same average annual rate of 6%, you’d have about $179, or almost 80% more than your initial investment, without having invested any more money! You then earned another 6% in year 2 - or $106 plus a little more than $6 in returns.Įxtend this example a few years or even decades out, and your balance will likely be higher. So what happened? Since your investment was compounding, your returns in year 2 were calculated using your new year 1 total of $106. Year 2: You leave your $106 invested, and a year later, you notice you have more than expected. Year 1: After one year, you’d have a balance of $106: your original $100 plus $6 in gains. Suppose you open an investment account with an initial deposit of $100, and you earn a hypothetical, conservative 6% annual return. How does compound interest work?Ĭompounding can be confusing, so here’s an example. Take a long-term approach and stay the course, and you have a better chance of your money growing over time. But many people use the terms “compound interest” and “compound returns” interchangeably.įor both savings and investment accounts, compound interest can work in your favor. Technically, your investments can earn “compound returns,” because investments don’t always grow and you don’t earn a set interest rate from them. The term "compound interest" is usually used for accounts that pay a set, guaranteed interest rate (like a savings account). When you have money in a savings account that earns interest, you receive interest on the amount you deposit and the interest you earned from the previous period. The snowball starts small, but as it keeps rolling, its momentum builds and it grows bigger and bigger. Think of it like a snowball rolling down a hill. Your money compounds when you earn interest or returns on money that’s already earned interest or returns. Start saving and investing today with Acorns Compounding is often described as “interest earned on interest,” and can help grow investors’ money quicker.īut you’ve got to understand compounding to really be able to take advantage of it. ![]()
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