Compound Growth
You can make your money grow at an accelerating pace over time by understanding and using the benefits of the compound growth that results when you reinvest the income that has been generated by the investment. If an investment pays you income (either interest or a dividend) and you use that income to buy more of the investment, you'll earn even more the next time around; you'll receive interest or dividends on your original investment as well as on the additional investment. Compounding can dramatically increase the value of your investment, especially over long periods of time.

What accounts for compounding's enormous power? The answer its that each year's return subsequently earns its own return, and so forth and so on. The money snowballs, in other words.

This chart shows the dramatic difference in the value of an investment when dividends are reinvested rather than paid to you in cash.

If you make an initial investment of $10,000 earning an average of 9% each year for 10 years and withdraw your earnings each year, you'll have $19,000 at the end of 10 years ($10,000 initial investment + 10 payments of $900). If you make the same investment and leave the annual earnings in the account to compound, you'll have $23,674, or nearly 25% more.

Compound growth works particularly well if you also invest on a regular basis. If you were to invest $200 each month for 10 years ($24,000 in all), earn an average of 9% per year and reinvest your earnings, you'd wind up with $38,703.

Calculating Compound Interest

Want an idea of how fast your money will grow? There is a quick way to do compound interest problems in your head. It gives a close approximation of the actual result, and it's commonly known as the Rule of 72.

The rule says that to find the number of years required to double your money at a given interest rate, you just divide the interest rate into 72.

For example, if you want to know how long it will take to double your money at eight percent interest, divide 8 into 72 and get 9 years.

(There is an assumption that interest is annually compounded, by the way).

The "rule of 72" remains reasonably accurate, as long as the interest rate is less than about twenty percent; at higher rates the error starts to become significant.

You can also run it backwards: if you want to double your money in six years, just divide 6 into 72 to find that it will require an interest rate of about 12 percent.