Compounding, also known as compound interest, is the process of taking what you earn from an investment and reinvesting that money back into the investment, earning you exponentially more money as time passes.

For example, if you invest $5,000 and have an interest rate of 4% each year, you will end up with $5,200 ($5,000 x 1.04) at end of year one. Instead of taking that $200 at the end of the year and using it for something else, you would reinvest that $200 with the addition of your original investment, or principal, being $5,000. So, by end of year two, you would end up with $5,408 ($5,200 x 1.04). See how this can grow exponentially? Compounding interest is a gold mine for those who invest in it.

As you can see, the interest you earned the first year was $200. The interest you earned the second year was $208. You didn’t have to do anything additional to earn that extra $8.00. By the end of the next year, you would result in $5,624.32, leaving you with an earning of $216.32. That $16.32 more than the interest you earned in year one and $8.32 more than you earned in year two.

The principal is the initial amount of money you choose to invest. Let’s say you choose to invest $10,000 now and you plan to reap the rewards 50 years from now. Each month, let’s say you choose to add $200 to the principal as you earn more money, and your annual compound interest rate is 5%. Your investment would be worth $617,109.19 at the end of 50 years!

Visit Investor.gov for a compound interest calculator.

Now let’s say you invested the same amount of money with the same, annual compound interest rate but only invested it for forty years. You would only have $360,319.35 by the end of the term! That is $256,789.84 less!

Visit Investor.gov for a compound interest calculator.

As you can see, the concept of compounding makes a massive difference in the amount of money you earn on an investment. In taking the first steps towards investing, it is important to not only notice the compound interest rate, but also to decide on a lengthy amount of time to allow your principal and interest to compound.

Interested in learning more about investing? Come back in a few weeks to see more of “A Beginner’s Guide to Investing.” In the meantime, follow me on Twitter for wealth management updates, news, and trends @EricaHill_KW!

Anyone who has mastered a new language knows what it’s like to reassign thoughts and ideas to match new words and sounds, to bend your brain around brand new meaning and reconfigure existing knowledge to move in patterns which may redefine or even defy previous experience.

Becoming a knowledgeable investor is a similar process, as it involves mastering the dialect of finance. The input of financial knowledge causes symbols which you thought you understood take on alternative context; to incorporate this new investing information requires rewiring what you know about monetary value (namely how it’s spent), how it’s produced, and how you can increase yours.

Investing may seem rather complex, but that complexity is largely an illusion. Financial advisors earn a fabulous living by capitalizing on the average individual’s economic ignorance. Adding a few basic and quickly mastered investing concepts to your knowledge base can be endlessly beneficial for anyone looking to boost their financial status. Information is strength, and financial information is financial strength. I believe in being as empowered as possible, so I’m building this beginner’s guide to investing for anyone craving control of their own economic state. If you want to avoid getting fleeced by financial advisors and improve your overall quality of life, this guide is for you.

What does it mean to invest?

Some people equate investing with high stakes gambling. To the cynical and uniformed, investing money might resemble finding which way the wind blows by standing on a cliff during a thunderstorm, and waving around handfuls of cash. Both of these viewpoints are a caricature of what investing actually is.

Simply put, to invest means to make money with money. Our world operates on money, and any financial endeavor requires funds to function. We acquire these funds by presenting the option to “invest,” or give money to their venture in exchange for a type of offering or mutual agreement. These offerings include stock (bite-size portions of company ownership), bonds (a kind of interest-earning IOU), real estate, or mutual funds, among other things.

The value of a stock, bond, or similar offering is contingent upon the economic strength of the venture which issued it. Since the future of all economic ventures are uncertain, placing your financial faith in any of them might seem like a shaky prospect, hence the financial market’s stigmatic reputation as no more than a glorified roulette wheel. This might be true, were it not for the fact that roulette is random, and a good investment is anything but. Making a wise investment involves analyzing market trends, determining how certain financial interests are performing, predicting how they will perform in the future, and investing in a manner which accounts for the best and worst possible performance scenarios.

Defining investing is only the beginning to a safe and profitable financial future. Check back soon for “A Beginner’s Guide to Investing: Compounding.” Do you want more financial tips, tricks, and news in the meantime? Follow me on Twitter @EricaHill_KW!