Time is your biggest ally as an investor. That’s because the more time you have to invest, the longer your investment can compound, or grow in value.
Compounding is a financial phenomenon that makes time work in your favor. It’s what happens when your investment earnings are added to your principal, forming a larger base on which earnings may accumulate. And as your investment base gets larger, it has the potential to grow faster.
All in the timing
The younger you are when you start investing, the more you will benefit from compounding. Let’s say you begin investing at age 25, putting $200 a month in a tax-deferred retirement plan earning 9%. Your friend starts investing in the same plan at 45, but puts away twice as much money as you — $400 a month. At age 65, you will both have invested a total of $96,000, but your investment would have grown to $884,000, while your friend’s investment would be worth only $268,000. The reason your investment has grown so much more than your friend’s — even though you both invested the same amount of money — is because of 20 extra years of compounding.
A 9% return on your investment isn’t guaranteed, and, if you invest in stocks, chances are your portfolio will earn more than 9% in some years, and may even lose money in others. But, if you invest in stocks for the long term, history is heavily in your favor: From 1926 through 2005 large-company stocks have provided an annualized return of 10.4%.
Compounding is a financial phenomenon that makes time work in your favor. It’s what happens when your investment earnings are added to your principal, forming a larger base on which earnings may accumulate. And as your investment base gets larger, it has the potential to grow faster.