• Definition of Compounding
• Compounding grows an asset's value by earning interest on both the initial principal and accumulated interest.

• It's a core principle of the time value of money (TMV).

• Importance in Investing

• Examples include dividend reinvestment plans (DRIPs), which buy more shares using dividends, creating a "double compounding" effect when dividends grow.

• Compound Interest Formula
  Future Value (FV) = PV × (1 + i/n)^(n×t)

• PV = Present value
• i = Annual interest rate
• n = Number of compounding periods per year

• t = Time in years

• The Power of Compounding Periods

• Increased compounding frequency amplifies growth:

  • Annual: $1,200,000 for a $1M investment at 20%/year.
  • Monthly: $1,219,391.
  • Daily: $1,221,336.

• Continuous Compounding

• Uses the formula: FV = P × e^(rt) (e 2.7183).

• Achieves the theoretical maximum growth.

• Examples of Compounding

• $10,000 at 5% annually grows to $16,288.95 after 10 years.

• Simple interest would only grow to $15,000, showing the advantage of compounding.

• The Rule of 72

• Estimate doubling time: Years = 72 / Interest Rate (%).

  • At 5%, doubling takes ~14.4 years.

• Simple vs. Compound Interest

• Simple Interest: Earns on principal only.

• Compound Interest: Earns on both principal and prior interest.

• Compounding Money

• Reinvest dividends or interest to enhance compounding effects.

• Best Example

  • High-yield savings accounts: Earn interest on growing balances for exponential growth.

Key Insights for Financial Growth

• Start Early: The earlier you begin, the more compounding works in your favor.
• Be Consistent: Regular investments amplify compounding benefits.
• Reinvest Earnings: Use dividends or interest to fuel further growth.
• Avoid Compounding Debt: Credit card balances grow exponentially with high rates, so pay them off promptly.

Leverage compounding to maximize wealth and minimize debt for long-term financial success.

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