Compounding occurs when returns are reinvested so they generate additional returns over time. It rewards patience and consistency, but projected returns remain uncertain and may not cover near-term spending needs. section 5.4 section 7.1.2
Use compounding to reason about long-term growth while checking its assumptions:
- Reinvesting gains produces growth on both the original capital and accumulated returns. section 7.1.2
- A steady 10% annual return on $100,000 reaches $259,374 after ten years when gains remain invested. section 7.1.2
- Compounding does not remove market, sector, or asset-specific risk, and selling during a bear market can lock in losses. section 5.4 section 7.1.2
Steady reinvestment versus a windfall
Ivan’s irregular gains and losses leave him with $100,000 after ten years, followed by a doubling to $200,000. Alicia earns 10% annually and withdraws nothing, reaching $259,374 through compounding. section 7.1.2
P(1 + i)n
Use the compound-interest expression P(1 + i)^n to connect starting capital, return rate, and time; the worked values produce $259,374. section 7.1.2
