Compounding is the process in which an account's earnings are reinvested to generate additional earnings over time. This growth occurs because the investment will generate earnings from both its initial balance as well as its accumulated earnings, resulting in exponential growth. This growth can be accelerated by making annual contributions.
You need to double your initial $1,000 contribution 10 times in order the reach the magic number of $1 million.
Just start contributing $100 each month. After three years, you will have contributed $3,600 and reached the first two milestones through contributions alone. Capital gains of $400 allows you to reach your third milestone of $4,000.
As time goes on, you will rely more and more on compounding and less and less on your annual contribution.
In order to reach $1 million by the age of 62, you will need to be doubling your money every 7 years. This can be accomplished with a 10% compounded annual growth rate.
The longer your money has to compound, the more it will grow. An 18 year old who adds a dollar into their account can expect to have $176 at retirement. A 55 year old can expect to have just $4 dollars. So don't wait to get started!
The half-way point is not $500,000 as it is on a linear scale. With exponential growth it is just $32,000 (5/10 doublings). The tipping point is just $8,000. Once you have reached that point, you are 50 years away from being a millionaire.
The DOW 100 year chart shows the classic
J-Stick or Hockey Stick pattern of exponential growth.
Viewing the 100 year chart on the log scale reveals the steady pace of progress and makes it much easier to see the long term trend.
The log scale also shows the extreme disruption that the crash of 1929 had on the economy which resulted in the Great Depression.
Compound Annual Growth Rates (CAGRs) provide a very simplistic model of a very chaotic stock market. The stock market itself has never been successfully modeled despite numerous attempts. Over long periods of time, the stock market has increased in value exponentially.
During the first decade of the 21st Century, the stock market experienced two major recessions. The Internet 1.0 tech bubble broke in 2000 and the subprime mortgage crises precipitated the Great Recession of 2008. This is an example of a "lost decade" in the stock market where overall values do not appreciate.
Despite the overall market's poor performance during the "Lost Decade", the tech sector continued to do well as companies like Apple, Amazon and Google came into their own. Investors in these and similar companies did quite well.