Compounding is described as the eighth wonder of the world and/or man’s greatest invention, compound interest is the silver bullet for growing your money. According to Benjamin Franklin, this is the best way he knew how to get rich.
Simply put, compounding means earning additional interest income on already earned interest income. It is the snowball effect that happens when your earnings generate even more earnings.
In other words, for every additional period you help your investment, you will earn interest not only on the principal but you will earn additional interest on the interest that was earned in the prior period. As a result even if the yield on your investment stayed constant, your money would keep growing at an ever increasing rate.
Say for example, on your 20th birthday you are gifted N100k below are 3 scenarios you could end up with on your 50th.
- If you kept it under your bed, you will still have a nominal N100k but inflation would have eaten deeply into it.
- If you invested it at 8% yield and didn’t reinvest the interest, you will still have N100k but have earned N400k over those 30 years.
- If you invested it at 8% and reinvested all your interest, you will have grown your stash to N1.01m
The above clearly demonstrates the impact of compounding.
Clearly, the interest rate you earn on your investment as well as the length of time you have to hold the investment would have big consequences for the final outcome of your investment portfolio
Now imagine if you took it a step further and added N20k to investment every year, your nest egg would have grown substantially to N3.27m.