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Compounding Interest · Acedra
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Compounding Interest
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Compounding is something that you might have heard of before. If you've ever taken a personal finance class, you've almost certainly come across this term. And for good reason, because compounding is what really makes your money work for you. In fact, Albert Einstein is quoted as saying that compounding is the eighth wonder of the world. So what is it and why is it so powerful? Let's say you invest 100 with an annual return of 10%. After one year, your 100 has earned 10% or 10.
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So now you have 110. With simple interest, this would continue year after year. You would still just earn 10 on your original 100 investment. But with compounding, your interest earns interest. So in the second year, you would earn 10% on your new total of 110. So you would earn 11, which gives you 121. And this continues to grow over time. The difference may not seem like a lot after just two years, but let's see what happens after 10 years.
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With simple interest, your 100 has earned you 10 every year for 10 years, so you have 200. But with compounding, your 100 has grown to 259 and 37 cents. This difference will continue to widen as time goes on. Let's say you started investing 5,000 every year at the age of 25 with a 7% annual return. By the time you're 65, you would have invested a total of 200,000. But your account would be worth over a million dollars. Over 80% of your money came from compound interest.
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And that's the power of compounding. This is why it's so important to start investing as early as possible. Thanks for watching and I'll see you in the next one.
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