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Why you should invest for the long-term and let the power of compounding work its magic

by , 31 July 2015

Investing with a long-term horizon has many benefits. By buying quality shares that pay dividends, you can stick them away and almost forget about them.

This is because your investments will benefit from compounding. It's a powerful way to build your wealth. It even works with your savings.

So what is compounding?

Read on to find out…

The ins and outs of compounding

Albert Einstein referred to compounding as ‘the eighth wonder of the world’. If you look at the power of compounding, you can understand why he said this.

Compounding works like this…

  • You put your money into an investment that pays a return.
  • At the end of year one, you reinvest that return (interest or dividends) into your initial investment. This lets your interest or dividends earn a return too.
  • At the end of year two, you do the same. But you’re already starting to benefit from the compound return.

Over the first ten years or so, the effect of compounding is slow. But the longer you leave your investment and keep reinvesting your interest or dividends, the better.

Think of compounding like a snowball, Mark Ford in Creating Wealth explains. At the start it’s very small, but as you roll it through the snow, it starts to get bigger. It then quickly becomes huge.

An example of compounding at work

Let’s say you’re 18-years old. You put R2,000 into a savings account for seven years. After that, you don’t add another cent.

Your R14,000 in the bank stays there, earning a rate of 10% a year.

By the time you retire, the money in your savings account will have grown to R944,641. That’s almost a million rand!

This shows the power of compounding. The secret to compounding is never taking any money out. You need to leave it well alone.

So there you have it. Why you should invest for the long-term and let the power of compounding work its magic.

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Why you should invest for the long-term and let the power of compounding work its magic
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