Dan Day : Northwestern Mutual Wealth Management Company - Understanding Compounding : Article: Understanding Compounding

Understanding Compounding

Putting Time to Work for You

Provided by Russell Investment Group

Consider this hypothetical example: Let's say you put away $1,000 today and didn't touch it. If it earned an average 8% return every year, it would be worth approximately $3,000 in 15 years and more than $10,000 in 30 years.* That's the power of compounding. But if you take money out, compounding doesn't get a chance to work for you.

How Compounding Works

Your investments can achieve compound growth in several ways: In a savings account, you can receive interest on interest.
If you own stock that splits, your gains from that point on will double.
If you own stock that pays cash dividends, you can reinvest that in more of the stock, increasing your next dividend payment.
With some bonds, interest payments get added to the original amount (or principal), which makes each successive payment larger.
Because taxes are deferred on your retirement portfolio, your investments' growth is also compounded when you compare it to what it would have been if taxes were taken out every year. Because taxes are deferred, you don't have to sell any investments to pay taxes on the year's gains. And all of your interest income can be reinvested. The result is that interest income keeps compounding, dividend reinvestments keep increasing, and your investment portfolio keeps growing.

This hypothetical example is for illustrative purposes only and is not intended to reflect the return of any actual investment. Investments do not typically grow at an even rate of return and may experience negative growth.

Source: Russell Investment Group

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