Investing is all about taking a resource, in this case money, and make it grow. For example, in order for you to have more money in the future, you may invest your current money in stocks, bonds, mutual funds, shares and property.
When investing your money, you can either withdraw your dividends or you can let the money run year after year, in order to receive compounded interest on your money.
Dividend is the return on your investment, which you can take out and use for other purposes, or invest it again. A dividend could be the income that makes you financially free – if, and only if, you have invested your money right.
Compounding is the effect of taking your dividend, or return on investment, and putting it back into your investment. The result is that your total investment always increases, and you continuously get a return on an increasing investment. In other words – you get interest on interest on interest…
This makes your money grow exponentially. Even though your investment may not grow significantly in the beginning, you will have a substantially bigger investment after years and years of investing.
Classic example of compounding
Two golfers made a bet on who would win the most holes on a 18 hole course. They started of with a bet of 10 cents on the first hole, and then doubled the bet for each hole.
If you do this kind of bet, you better have a lot of money!
Let us say that the same player won each hole - then the looser will have paid a total amount of $26.214 and 30 cents to the winner. See how it works in the table below:
As you can see the bet starts of at 10 cents at the first hole. The bet is 20 cents on the second hole, and so on. The bet is "only" about $100 on the 11th hole, but on the 18th hole the bet on that hole is $13.107 and 20 cents. And the total bet on all 18 holes is $26.214 and 30 cents.
This is the effect of compounding!
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