The Mighty Dollar

If you want to make more money, read on. Compounding is not the most glamorous money making strategy going around, but it’s powerful none the less. Compounding is essentially the reinvestment of interest or investment earnings to produce more interest or earnings in the future - or to compound future earnings.

Investopedia defines compounding as follows:

“The ability of an asset to generate earnings, which are then reinvested in order to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings.”

Could you save $5 per day? Could you find an extra $5 to put away for an extended period. It may not sound like much but if you took that $5 each day and put it in a bank account paying 5% interest, it would be worth over $60,000 in 20 years time. If you could earn 7% instead of 5%, that $5 would grow to nearly $80,000 in 20 years. Now these figures don’t allow for taxes, but even so that’s alot of money to be made.

The above example illustrates 2 things. First, by putting in place a simple savings plan ($5 is not much for a lot of us) and applying discipline over the long term, some very impressive gains can be made. It’s all about forming a habit. Applying the same discipline day in and day out until it becomes second nature.

The second point I’d like to make about the example above is the sensitivity of the ultimate gain to the return you receive on your investment. There’s nearly $20,000 difference in the eventual sum if you increase the return by just 2 percentage points.
So you should always be striving for that little bit extra. When all other things are equal, it is definitely worth switching to the product with the higher return (I say when all other things are equal because you need to take into account the varying levels of risk inherent in various investments). It will pay off in the end.

The flip side to this is controlling costs, particularly with managed investments. Make sure to shop around when looking for a professional to manage your money. If one is charging an extra half of a percentage point in management fees - make sure they are worth it. Remember that it will eat into the money you’ll earn over the long term.

Compounding may be boring - it’s not as exciting as making a killing in the stock market overnight, but it’s a powerful tool. And the younger you are the better. Time is your best friend when it comes to making money with compounding.