Finance: The Importance of Compounding

Topics: Compound interest, Retirement, Investment Pages: 1 (310 words) Published: January 17, 2011
The Importance of Compounding
There are many important features of compounding. One valuable feature of compounding is that it makes money grow, and grow fast, especially when compounding an annuity. An annuity is a series of installments, usually yearly, in an account that bears interest. Once interest is earned, an annuity allows that interest to be compounded setting the way for an investor to earn interest on interest.

Another important feature of compounding is time. The longer money is left in an account accruing interest, the more opportunity one has to earn a larger amount of money. It is also important to begin investing early. Again, the longer the time the money has to earn interest, the more profit one will gain. For example, two people save the same amount, say $2,000 per year at five percent interest; one begins at age 20 and saves for five years until age 25, effectively saving $20,000 in five years. The other begins saving ten years later, at age 30 until age 50, effectively saving the same amount. If neither touches their money until age 50, the person who began saving at age 20 will be more fortuitous in her earnings than the one who began saving at age 30. This is because the person who began saving early was able to compound their interest heavily over the five year period while they were making annuity payments, and then let the interest accrue for the remaining period.

These two very important features will impact my personal financial goals in a positive way. If I begin saving early and heavily for a few years, I will be able to reap the benefits of compounding interest earned later. This is a good way to begin saving for retirement. While not the only avenue, and maybe not the most profitable, it is safe.
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