Compounding (redirected from compounded)

Compounding

The process of accumulating the time value of money forward in time. For example, interest earned in one period earns additional interest during each subsequent time period.

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Compounding

The process of earning interest on a loan or other fixed-income instrument where the interest can itself earn interest. That is, interest previously calculated is included in the calculation of future interest. For example, suppose someone had the same certificate of deposit for $1000 that pays 3%, compounding each month. The interest paid is $30 in the first month (3% of $1,000), $30.90 in the second month (3% of $1,030), and so forth. In this situation, the more frequently interest is compounded, the higher the yield will be on the instrument. See also: Amortization, Time value of money, Simple interest.

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Compounding. Compounding occurs when your investment earnings or savings account interest is added to your principal, forming a larger base on which future earnings may accumulate.

As your investment base gets larger, it has the potential to grow faster. And the longer your money is invested, the more you stand to gain from compounding.

For example, if you invested $10,000 earning 8% annually and reinvested all your earnings, you'd have $21,589 in your account after 10 years.

If instead of reinvesting you withdrew the earnings each year, you would have collected $800 a year, or $8,000 over the 10 years. The $3,589 difference is the benefit of 10 years of compound growth.

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Compounding

What Does Compounding Mean?

The ability of an asset to generate earnings, which then are reinvested to generate their own earnings. In other words, compounding refers to generating earnings from previous earnings. Also known as compound interest.

Investopedia explains Compounding

Suppose you invest $10,000 in Cory's Tequila Company. The first year, the shares rise 20%. The investment is now worth $12,000. In year 2, the shares appreciate another 20% so that your $12,000 grows to $14,400. Rather than your shares appreciating an additional $2,000 (20%) as they did in the first year, they appreciate an additional $400 because the $2,000 you gained in the first year grew by 20% as well. If you extrapolate the process, the numbers can start to get very big as your previous earnings earn returns of their own. In fact, $10,000 invested at 20% annually for 25 years would grow to nearly $1,000,000 without your having invested another dime! Albert Einstein was rumored to have called compounding the eighth wonder of the world.

Related Terms:
• Annual Percentage Yield—APY
• Compound Annual Growth Rate—CAGR
• Dividend
• Interest Rate
• Money Market Account