On the Power of Compounding on Returns

I have written many times before about the power of compounding. For example, even when dividend yields are small at say 2% reinvesting any dividends received over many years will multiple the yield many times over with compounding. I came across the a thoughtful piece on the magic of compounding by Richard C. Young at Young Research. From the article:

Here’s an excerpt: “As each rate of return doubles, your profit more than doubles. When you compound at 2% for 20 years, your profit is 2.2X your profit when compounding at 1%. And when you compound at 8% for 20 years, you have more than 3X the profit that you do when you compound at 4%. Double your return again, which is admittedly unrealistic over a 20-year period, and your profit is 5X your profit when compounding for 20 years at 8%.”

That logic doesn’t only apply to dividends, but it illustrates well the benefits of higher yields. On the chart below, you can see the differences in profit as returns move from 2% to 4%, and from 4% to 8%. It is astonishing how your money will pile up when given time to compound.

Source: Avalanche! It Is Astonishing How Your Money will Pile Up, Young Research

As clearly demonstrated above, the effect of compounding cannot be understated.

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