It is said that the great Albert Einstein once said that the most potent force in this universe was the theory of compounding. In finance and investing, this force shows itself through the idea of compounding interest. In layman’s terms, compounding profits means that businesses begin to earn profit on the interest that it is receiving, which can multiply the business’ money at a faster or accelerating rate.
In short, if you have $100 and earn 10% in profit, you have $110. Then, if you make 10% on the interest, you will end up with $121. And so on, until your original $100 will eventually get eclipsed by the amount of the profit you get. It is the reason why a lot of top investors are very successful. Anyone can benefit from disciplined investing programs.
Visit https://en.wikipedia.org/wiki/Interest_rate to know more about profit rates.
Table of Contents
Three elements that can determine compound profit returns
Three factors can influence the rate at which the investor’s profit compounds. These are:
Interest rates that the investors earn on the investment, or the profit that was made – If a person is investing in stocks, this will be their total profit from their dividends and capital gains.
Time left to grow – The more time people give their money to build upon itself, the more it gains compounding profit.
The tax rate, and when people pay taxes on the profits, their investment is earning – People will end up with more money if they do not have to pay taxes, or until the end of the compounding term instead on paying at the end of every fiscal year.
It is why accounts like the conventional Individual Retirement Account, Roth Individual Retirement Account, the 401K account, Simplified Employee Pension Individual Retirement Arrangement, as well as other tax-deferred Individual Retirement Arrangements are vital.
Compound Interest, as well as the time value of the money
The foundation behind the compounding dividends is its concept of the time value of the investment. It states that the value of investment can change depending on when it was received. If you have $500 today, it is better to receive it one year from now because you can invest the money to help generate interest, income and dividends.
Compounding interests allow the capital to grow. By postponing receipts of the $500, the investor’s opportunity costs will rise. Opportunity costs are losses of possible gains if actions are not chosen – in this situation, the money investors do not receive in they do not do anything about it.
If the investor does not invest their $100, they have lost the chance to earn $10 that they can gain in a year. In ten years, their $100 would have been $259 – the investor missed the chance to earn $159 by not investing their money. If an individual understands the time value of theirinvestment, they will see here that the compound interest, as well as their patience, are the key ingredients when it comes to increasing their wealth.
For instance, if an individual wanted a million dollars when they retire, and could $800 every month, with an 8% profit rate on the investment each year, can they get to that million dollars in time? The United States Securities Exchange Commission can provide a calculator to help investors figure out the time frame of which you can achieve your goal. In this scenario, it will take more or less 29 years to break the one-million-dollar mark.
Compound interest result
The best way to know and understand the concept of compound interest is to put the numbers on the compound dividends table. It will show investors how their money will increase dramatically over time. Imagine you know someone willing to invest and sets aside $10,000.
Check the dividend chart to see the influence of time, as well as the rate of return on their investment. Once you understand everything about compound interest rates, it will become clear that saving money without any plans is not the key to increasing your bank account.
Resist the temptation of high return rates trough risks
One look at the compound profit rate char and you will want to do everything to earn higher return rates. High return rates can be very dangerous since they always bring higher risks. Unless people know what, they are doing, no matter how good or successful they are, they will always want to avoid risks and the possibility of losing a lot of money that is over their investment budget.
