Compounding is a powerful investing concept that involves earning returns on both your original investment and on returns you received previously. For compounding to work, you need to reinvest your returns back into your account. For example, you invest $1,000 and earn a 6% rate of return. In the first year, you would make $60, bringing your total investment to $1,060, if you reinvest your return.
Next year, you would earn a return on your total $1,060 investment. If your return were once again 6%, you’d make $63.60, bringing your total investment to $1,123.60.
Over the long term, compound growth can multiply your initial investment exponentially. In our hypothetical example, if your return stayed at 6%, by year 30, your annual earnings would be $325.10. That’s more than five times the $60 return you earned the first year — just for sitting by and letting your money grow.
Make compound growth work for you
Take the effort out of compounding by reinvesting your earnings automatically. In turn, those earnings add to the value of your account and boost the potential to earn even more. The key? Patience. Don't be tempted to withdraw the funds when they grow. Keep in mind that if you hold your investments in a taxable account, you'll still be taxed on the interest, dividends, and capital gains you receive, even if you reinvest them into the account.
Want to help build your money faster? Add new money to the account regularly. Your financial services provider can help you establish such an automatic transfer easily, or your employer might offer the option to do so with a split direct deposit.
Compounding relies on the power of time. Start saving and investing early — either in an account that earns interest or with an investment that pays dividends that can be reinvested.
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The example provided is hypothetical and is provided for informational purposes only. It is not intended to represent any specific investment, nor is it indicative of future results.
Wells Fargo and Company and its Affiliates do not provide tax or legal advice. This communication cannot be relied upon to avoid tax penalties. Please consult your tax and legal advisors to determine how this information may apply to your own situation. Whether any planned tax result is realized by you depends on the specific facts of your own situation at the time your tax return is filed.
This information is provided for educational and illustrative purposes only and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. Investing involves risk, including the possible loss of principal. Since each investor's situation is unique, you should review your specific investment objectives, risk tolerance and liquidity needs with your financial professional to help determine an appropriate investment strategy.
Past performance is not a guarantee of future results.
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