The Advantages of Having Long Term Compound Interest Rates

The joys of compounding don’t end there. For one thing, if you have a certain goal in mind (say, you plan to buy a house in 10 years and figure you’ll need $20,000 for the down payment), compounding lets you figure out how much you’ll need to set aside on a regular basis and what sort of return you’ll need to reach your goal. In the preceding example, if you’ve got 10 years to invest and assume that you can earn 10% a year (not an unreasonable assumption), then all you need to do is set aside about $96 a month to achieve your targeted down payment goal.

What can be an even more entertaining and compelling illustration of long-term compounding, particularly for someone young with a long-term investment horizon, is playing around with some numbers to see what they can become, given enough time. For instance, since small stocks have returned 12.5% since Calvin Coolidge was in the White House, assume for a second that, in 1926, your great-grandfather put $100 into a stock that, ultimately, returned that very same 12.5%. From there, he did nothing (oh, maybe he mowed the lawn and took in Coney Island a couple of times), but he just left that money alone. By 1998, that initial $100 would have grown to more than three-quarters of a million dollars, thanks to time and compounding, without a single penny being added to it. Granted, very few of us are looking at a 72-year investment time frame, but this does illustrate how powerful a catalyst time can be when it comes to making your money grow.

Want to see for yourself how compounding works and why it’s such a powerful financial weapon? Check out the Power of Compounding Calculator at http://www.strong-funds.com/strong/LearningCenter/compound.htm. The calculator lets you play with various rates of return, time frames, and investment amounts so that you can see how much a certain amount of money, invested over a period of time, can grow, often substantially.

If you’re sold on the value of investing over the long-term (and if the example of Gramps doesn’t win you over, I’m hard pressed to think of what will), let’s turn to the various ways that you can invest and, with any good fortune, reap the long-term rewards.