Article 1 — The Power of Compounding

One crucial part of investing is understanding the power of compounding. Most people think that you need a lot of money to start investing. In reality, you can invest even $1 at some brokers today. Investing even a few dollars each month is better than nothing, because at the very least, you can outpace inflation and avoid losing money.

The most important factor is time, not the amount of money. That's where the power of compounding makes all the difference.

Why does Jack earn more?

1. Early start of investing

Jack starts investing at age 25, putting in $20,000 per year for just 10 years (until age 34). He then stops making new contributions, but lets his investments grow. Jill, however, starts later at age 35, and invests the same amount every year for 30 years.

2. The power of compound interest

Jack's money has far more time to grow and benefit from compounding. Although he invested for only 10 years, his investments have over 40 years to grow. Jill's investments, meanwhile, grow for 30 years.

Compound interest means you earn not only on the original investment, but also on the gains already generated. The longer you keep your money invested, the stronger this effect becomes.

3. Results

By age 65, Jack ends up with $2,250,731, while Jill ends up with $2,021,461 if the annual return is 7%.

Even though Jill invested for a much longer time — and contributed more money in total — Jack's early start gave his investments a major advantage, allowing compounding to work much more powerfully for him.