| Glossary of
Financial Terms | | |
 The
Companion Advisor: Taxes
& Estates
Compounding your tax refund for a richer future
A Companion Advisor Article
Money Management Newsletter - May 1998
 You've probably heard someone tell you to make your money work for you. There’s a way of doing just that and it's called compounding.
The short-term benefits of compounding are admittedly limited. The long-term benefits, however, can be dramatic.
If you invested $100 on the first business day of each month for 10 years at an eight per cent rate of return compounded monthly, you would accumulate $18,128, including your principal of $12,000. If you invested the same amount at a 10 per cent rate of return, the total investment would be worth $20,146, a difference of $2,018.
But imagine investing that $100 over a longer period. After 20 years, your principal investment of $24,000, earning 10 per cent compounded monthly, would be worth $72,399. Your $100 a month invested over 30 years would earn $207,929, a substantial increase. Extend that over 40 years and your money would grow to $559,461.
Combine a higher rate of return with your investment and the effects of compounding are markedly greater. For example, if you invested your money at 12 per cent over 40 years, you would have earned a staggering $979,307. Those five additional percentage points mean a difference of $419,846!
Compounding is money multiplying itself. Investors earn income on their income earned. Income payments grow each year because the amount upon which the payments are based grows each year, too.
Perhaps the best way to understand its effect is by looking at two individuals who have similar investments of $1,000 each, both earning 10 per cent each year. Their attitudes towards savings are very different, however. The first person is a spender while the second is an investor.
The spender spends the growth each year and continues to receive the same $100 year after year. After 10 years, the spender has only the original $1,000 having spent the $1,000 of earned income.
The investor reinvests the earned income each year. So in the second year, the investor earns 10 per cent on the $1,100. Because the value of the investment is constantly increasing, income is earned on the income of previous years.
That's called compounding. After 10 years, the investor has $2,593.74 – almost three times as much as the spender. It's a painless way to invest and have your investment grow at the same time.
A handy tool for measuring the growth of your investment is the "rule of 72." Simply divide the number 72 by the annual rate of return your investment will earn and the result will tell you how many years it will take for your investment to double.
For example, if you invested $1,000 at 10 per cent, your investment will double in 7.2 years (72/10=7.2). Invest the same amount at 15 per cent and it will double in 4.8 years (72/15=4.8).
These examples illustrate that the two most important factors when making an investment decision are time and rate of return. The longer you allow your investment to grow and the greater the rate of return, the larger the future value of your investment will be. You've seen the dramatic difference between a 10-year and 20-year investment and what can happen when the rate of return is appreciably higher within the same period.
Remember to have patience, to allow your money to work for you. The cumulative effect of compounding can work wonders for your investment and your peace of mind.
If you're saving for retirement, your children's education or perhaps a dream vacation, choose investments that will work hardest for you and give them time to grow. The longer you delay, the harder your money will have to work for you.
Speak to a professional financial adviser and discover the benefits of compounding. You won't be disappointed.
| Spender |
| Year |
Investment Value
(Start Of Year) |
Income Spent |
1
2
3
8
9
10 |
$1,000.00
$1,000.00
$1,000.00
$1,000.00
$1,000.00
$1,000.00 |
$100.00
$100.00
$100.00
$100.00
$100.00
$100.00 |
| Starting Value |
$1,000.00 |
Total Income Earned
Total Income Spent
|
$1,000.00
$1,000.00 |
| Value Of Investment After 10 Years |
$1,000.00 |
| Investor |
| Year |
Investment Value
(Start Of Year) |
Income Spent |
1
2
3
8
9
10 |
$1,000.00
$1,100.00
$1,210.00
$1,948.72
$2,143.59
$2,357.95 |
$100.00
$110.00
$121.00
$194.87
$214.36
$235.79 |
| Starting Value |
$1,000.00 |
Total Income Earned
Total Income Spent
|
$1,593.74
$1,593.74 |
| Value Of Investment After 10 Years |
$2,593.74 |
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 © , Fiscal Agents Money Management Newsletter
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(905) 844-7700
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