Saturday, December 25, 2010

Compounding

The concept of compounding is in essence earnings from an investment's earnings (or in the case of e.g. a bank deposit, it is interest on interest). Compounding growth is a powerful concept in investing as it can result in rapid growth of wealth over time. A related term is reinvestment, in essence reinvestment activates the power of compounding growth by reinvesting any capital or income distributions. In order to calculate the compounding growth rate you need to use the following formula: Rc=((1+r)^t)-1 where Rc is the compounding rate of growth, r is the rate of return, and t is the number of compounding periods. Thus if a return is 10% and the number of compounding periods is 10 then the compounded rate of growth is 159% so you can see the power of compound growth over time.

Synonyms: Compound interest, Compounding growth, Interest on interest
 
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