Power your portfolio with compounding
Compounding sounds complicated, but it is a simple concept that is one of the most powerful tools you can utilize when it comes to growing your wealth.
If you are standing at the top of a hill and want to build a large snowball, you can start with a small handful of snow, and with a little push down the hill, the snow builds on itself. The longer it rolls, the bigger it gets. Compounding works pretty much the same way; the longer you stay in the market, the better chance your investments have to grow.
How does it work?
Imagine you invested $100 into your favorite technology company. This year, the stock price of that company grows by 10%, making your total investment worth $110. If the stock price grows by 10% again next year, the value would increase by $11 instead of $10 due to the fact that the value of your investment had grown the year before. Obviously, your investments may not increase every year so this is just an example to explain the concept of compounding.
Three key points to keep in mind:
- Get started now: Get that initial investment made early, no matter how small. Time gives your money the chance to build on itself; the earlier you start, the more likely you are to get the benefits of compounding. Even an avalanche starts with a snow flake.
- Add to your investments and reinvest your income: Adding even a small amount on a regular basis can give you a big boost later. Determine the amount you are comfortable committing on a regular basis. Additionally, many stocks and mutual funds pay income through dividends. Reinvesting that small amount can be impactful.
- Stay invested. Once you've begun investing, stick to your plan even if the market takes a dip now and again. Compounding works best if you stay invested.
- Create a long-term plan and get invested. The earlier you invest, the more time your investment has to benefit from compounding.
- Add to your investment on a regular basis, and make sure your dividends are set to be automatically reinvested in your account. Even a small amount can provide a big lift later.
- Stay invested. Compounding works best if you stay invested.