Compound growth means an investment can earn growth not only on the money you put in, but also on growth that has already stayed invested. One small number shows it better than any definition.
Imagine R10,000 grows by 8% in a year, with no fees or tax. It becomes R10,800. If the same 8% occurs in the next year, the growth is calculated on R10,800, not only on the original R10,000. The balance would become R11,664. The extra R64 is growth on earlier growth.
That is the whole mechanism. It is also why time tends to matter more than the size of any single contribution.
Real investments do not usually deliver the same return every year. Markets rise and fall, fees reduce the amount that remains, tax may apply and inflation changes what the future balance can buy. The example explains the mechanism; it is not a forecast. Compounding can also work against you when interest is charged on growing debt.
Try this now
Look at one long-term investment and find four facts: the opening value, money added, money withdrawn and closing value. Do not call the difference “return” until contributions, withdrawals, fees and the measurement dates have been separated.
Ask your advisor
- Which return, fee and inflation assumptions are being used in my projection, and are they shown before or after costs?
Illustrative growth rates are assumptions, not promises.