The Power of Compounding

If I asked you, how long would it take to double your money, assuming that you invested $1,000 with an average annual rate of return of 10%, what would be your answer?

10 Years?

The natural thought process may determine, that since 10% of $1,000 is $100, it would require that return 10 times – or over the course of 10 years to double that $1,000 and achieve $2,000.

Now if I was to ask you how long it would take to 10X your initial investment, what would your answer be? Using the same logic above, you might guess 100 Years.

Actually…

In reality, this couldn’t be farther from the truth. And that’s the beauty of compounding! To actually achieve 2x at an annual rate of return at 10%, it would only take about 7.5 years. This is because each subsequent year would have a 10% yield on the principal as well as all the returns of the prior years. The formula we can use to verify this is 1.10^7.5, which is just over 2.0. The formula is taking 110% and multiplying it by itself 7.5 times (or over 7.5 years).

Let’s take a more consecutive approach…the rule of thumb for investing in an index fund such as the S&P500 in U.S.A is said to yield around 7% on average, annually. How long would it take then, realistically, to double your money at this rate? About 10 years. 1.07^10 = ~2.

How about 10X?

Now, how many years do you think it would take to 10X your initial capital? Probably just under 100 years right?

Nope. It would only take 34 years to 10x your capital. 1.07^34=~10.

While it may seem like a lot of years to double or 10X your investment, consider the size of the investment. Let’s assume you save $100,000 by the age of 30 and invest it with the 7% average rate of return. By the age of 64, that $100,000 would compound to $1,000,000 and you would achieve millionaire status, just by having saved $100,000 by the age of 30.

That is the power of compounding. Time and Savings will be your best friends, for years to come.