Definition

Compounding is the process of earning returns on both the original investment (principal) and the accumulated returns from previous periods. Compounding can simply be thought of as “money making money and that new money making even more money over time.”

Analogy

Think of compounding as baking a sourdough starter. At first, it’s just a tiny batch of dough. But every time you “feed” it (add more flour and water), it grows exponentially, creating enough dough to make several loaves. Similarly, when you reinvest returns into your portfolio, the "starter" grows into something much bigger over time.\

Compounding Power

Investing $100/month at 8% for 20 years grows to $59,575. Investing $100/month at 8% for 30 years grows to $149,035. That’s 2.5x more just by investing 10 years longer!

Little-Known Fact

Albert Einstein reportedly called compounding "the eighth wonder of the world." He said, "He who understands it, earns it; he who doesn’t, pays it." This highlights the double-edged nature of compounding—it can work for you (in investments) or against you (in debt).

Action Step

Think of an area outside of finance where you’ve seen the effects of compounding (e.g., learning a new skill, building a habit, or networking).

How did the power of compounding affect those areas?