Saving

Compounding is the most powerful force in the universe, Einstein said — this example shows why

You've heard the phrase "a penny saved is a penny earned." But what is a penny compounded? A whole lot more than you might think.

That's because of a powerful mathematical process called compounding, which Albert Einstein is said to have called "the most powerful force in the universe."

"Compound interest is the eighth wonder of the world," Einstein reportedly said. "He who understands it, earns it. He who doesn't, pays it."

Compound interest is the interest you earn on your money, plus the interest it's already accrued.

For example, if you deposit $100 in a savings account with a 5% interest rate, after one year, you'll have $105. If that interest compounds, in year two, you'll earn 5% on the $105, not just the initial deposit of $100.

So, after two years, your savings account would contain $110.25, and after three years, $115.76. With time and regular contributions, the compounding process can help you grow your wealth considerably.

How a single cent can grow into a fortune

To illustrate how powerful compounding can be, imagine that you're starting out with a single cent, and that it doubles every day. Thanks to that compounding, how much money would you have after a week or a month?

Let's start at the beginning. After two days, you'd have $0.02. After three days, you'd have $0.04, and so on. At the end of a week, seven days later, your single cent would have compounded into $0.64. And after a month, or 30 days, you'd have over $5,300,000. That's the power of compounding.

VIDEO2:4402:44
The power of compound interest: How it helps an investment strategy

Video by Jason Armesto

To bring in a real-world example of the power of compounding, consider someone who starts saving $5,000 a year for retirement at age 25. By age 65, they could have twice as much money as someone who waits until age 35 to start stashing money away.

Build compounding into your financial strategy

Experts say you should stick to a long-term strategy of saving and investing, partly because it allows the power of compounding to do much of the heavy lifting as you build wealth. "An average investor with a longer time horizon is going to have better results than an amazing investor with a shorter time horizon," Joshua Brown, CEO of investment advisory firm Ritholtz Wealth Management, recently told Grow.

Taking advantage of compounding is relatively easy: Start as early as possible, make regular contributions, and avoid tapping your account if you can avoid it. That will help you stay on track to meet your future goals.

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All investments involve risk, including loss of principal. The contents presented herein are provided for general investment education and informational purposes only and do not constitute an offer to sell or a solicitation to buy any specific securities or engage in any particular investment strategy. Acorns is not engaged in rendering any tax, legal, or accounting advice. Please consult with a qualified professional for this type of advice.

Any references to past performance, regarding financial markets or otherwise, do not indicate or guarantee future results. Forward-looking statements, including without limitations investment outcomes and projections, are hypothetical and educational in nature. The results of any hypothetical projections can and may differ from actual investment results had the strategies been deployed in actual securities accounts. It is not possible to invest directly in an index.

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