What Is Compounding and How It Helps Your Money Grow

By Stuart Robertson

There’s often-told story that Albert Einstein said, "The most powerful force in the universe is compound interest." Whether he said it or not, the power of compound growth in investing is pretty brilliant.

Benjamin Franklin may have said it best in describing it, “Money makes money. And the money that money makes, makes money.” Compounding is the impact of interest, dividends, and price growth securites on the money you invest in securities (e.g. stocks and bonds) and how this builds on itself over a period of time.

In fact, with regular contributions plus the power of compounding, building over $1,000,000, if not more, with your 401(k) account is quite feasible. When you contribute to your 401(k) (and receive your employer match too if applicable) and combine it with investment returns over time, you are putting yourself in much better position to be set for life upon reaching retirement age.

An Example on the Magical Power of Compounding
Here’s an idea of how it can work with this hypothetical example. Let’s assume Anne is able to contribute $10,000 per year ($833 per month) and receives $4,000 per year ($333 per month) as an employer matching contribution. And her investments provide an 8% return each year. As you can see, in 20 years, she has accumulated nearly $700,000 on $280,000 in contributions ($200,000 she contributed and received $80,000 from her employer). That’s well more than double of what she put in.

Power of Compounding

Better yet, compounding can provide even greater returns over more and more time. In this example, Anne has over $4,000,000 on $560,000 in contributions ($400,000 of her contributions and $160,000 from her employer) in 40 years! That’s a big, juicy nest egg to retire and pursue other dreams and passions. So, what are you waiting for? Contribute regularly to your 401(k) and set your course for financial freedom.

Performance Not Guaranteed: Why Investing (like life events) Is Not Guaranteed
In this example, returns are the same each year. That’s not the real world, although a realistic average return at least historically. Markets are unpredictable. Stocks and/or bonds may do well one year and bad in another. An economic event may occur. There are so many things that cannot be forecast, that markets do swing. If you believe in innovation and the ability for businesses to grow, over the long-term, investing in the markets can build you much greater savings than holding all your money in cash. This example does not consider tax consequences upon withdrawing money in retirement.

Meet the Author