Experienced and expert investors often advise people to start investing while they’re young, and to stay consistent and think long-term.
One of the main reasons for this is the power of compounding. Let’s break down what compound growth means and why it matters to investors.
How compound growth works
Compound growth happens when you earn money not just on your original investment, but also on the money your investment earns over time.
One way to understand this concept is by comparing simple interest and compound interest. Simple interest only applies to the principal or original amount invested or borrowed.
Meanwhile, compound interest applies to both the principal amount and any interest accumulated.
Here’s an example:
Let’s say you invested P10,000 in a product that offers 5% annual interest over 5 years. See the difference between earning simple and compound interest:
| Yearly earnings via simple interest | Yearly earnings via compound interest | |
| Year 1 | P500 | P500 |
| Year 2 | P500 | P525 |
| Year 3 | P500 | P551.25 |
| Year 4 | P500 | P578.81 |
| Year 5 | P500 | P607.75 |
| Total | P2,500 | P2,762.82 |
This example shows compound interest can allow earnings to grow faster, especially if you’ll stay invested for a long time and reinvest your investment proceeds.
Note that compound growth can also apply to loan interest and cause debt to rise rapidly. Before borrowing money, make sure it’s for a good purpose and that you fully understand the loan terms.
Benefits of compound growth for investors
Here’s how the power of compounding can help investors reach money goals:
1. Your money may grow faster over time
The longer you leave your money invested and reinvest your returns, the more you might benefit from compound growth. That’s because each year, your earnings can start gaining their own earnings, creating a snowball effect.
Keep in mind, however, that investment earnings aren’t always guaranteed. Your actual returns may vary each year because of different factors that can affect an investment’s performance.
2. You can start small
Even small investments can grow over time, especially if you’ll let your earnings compound. You don’t need to wait until you have a huge amount to invest.
Instead, you can start when you’re ready then add to your investments regularly. In 10, 20, or 30 years, your small investments and compounded returns may add up to a huge amount.
3. It rewards patience and consistency
Compound growth works best when you give it time, consistently add to your investments, and keep reinvesting what they earn.
Instead of chasing quick returns (and possibly taking on too much risk by doing so), you’ll focus on long-term growth.
You won’t withdraw and spend your profits needlessly since you understand how reinvesting allows your money to potentially earn more money for you.
4. It builds discipline
Watching your money grow can also be motivating, helping reinforce the habit of investing. This can teach you to practice self-restraint, be mindful of unnecessary purchases, and value delayed gratification by focusing on the more important goals.
You may find that investing isn’t just about money – time is just as important. The earlier you start, the smaller the amount you’ll need. The harder your money works, the less you might need to.
