If you’re interested in investing, you’ve most likely heard about “compound returns”. Compound returns are one of the most important topics, and one that all investors should be aware of. In a world filled with inflation, compound returns will help you protect and increase your wealth.
Compound returns refer to the cumulative effects of gains or losses over a defined period of time. (Often, investors calculate returns on an annual basis). To put it more clearly, let’s say you invest $1,000 dollars and enjoy 50 percent returns (quite the investor, aren’t you?) for the year.
At the end of the year you thus have $1,500 dollars. Next, you reinvest that $1,500 dollars and again enjoy 50 percent gains (move over Warren Buffet!). That’s a profit of $750 dollars, so now you’ve got $2,250 in your account. The next year the same thing happens again and you pull in $1,125 dollars, leaving you with $3,375 dollars.
Notice how your initial investment of $1,000 dollars turned into an investment of $3,375 in just a few years? Those are huge gains, and you were able to secure them because of compound gains.
Without compound returns (adding your gains to your investments), you would have profited only $1,500, instead of nearly $2,500.
Obviously, compound returns can make a big difference. In fact, over time and with high returns, compound returns can actually lead to exponential growth!
Since many types of investments allow people to tap into compound returns, they are very valuable for increasing wealth. Even steady gains, like 7 percent per year, can really add up over time.
Let’s say you have a $100 thousand dollar retirement account and continually invest in bonds that offer 7 percent gains per year. Let’s assume you continue with this investment strategy for 30 years and never add any outside money to the account. Guess how much you’d end up with.
$761,225.50 dollars. If you extend your investment period by only 5 years (so 35 years in total), you’ll end up with over a million dollars in the bank! That’s a heck of a lot of money, especially given that your initial investment was only $100,000 dollars.
Compound returns are very, very important for people looking to build up their wealth for retirement. If you save and invest well when you’re younger, there’s a good chance that you’ll be able to save up enough money to live comfortably through retirement.
In a best case scenario, you’ll be able to save up enough to live off of interest alone once you retire. So if you’re looking to build up your retirement account, start early because compound interest rates can make a huge difference over time. Remember, just a few extra years of time investing can lead to big gains.
Understanding Compound Interest Rates
Wondering what is compound interest? It is very closely related to the term compound returns.
With compound interest rates, the money you gain (or pay) because of interest is added back to the original balance. You are then paid (or pay) interest rates on the money you gained through interest (as well as all money you have or owe in the balance).
When you’re taking out loans or parking your money in a bank account that offers compound interest, you should take a moment to figure out how much you’d earn (or have to pay) due to the interest. An easy way to do this is to use an interest rate calculator, which will help you easily compute how much you will earn or pay due to interest. A compounding interest rate calculator is a valuable tool everyone should use.
When interest or return rates are compounding, it means investors have to watch their finances very closely. Since returns and interest are added to the initial balance, they magnify losses and returns. Just keep that in mind if you’re looking to invest in anything or take out loans that involve compound interest rates.