## Understanding Compounding Returns

What does “compound interest” or “compound returns” really mean? It is a fairly simple concept. It means that any interest earned is added to the principal amount and any future interest is earned on the new principle value. If we are talking about a bank savings account this has the same affect but the interest amounts are so small that it is not exciting at all. In fact, it is not even interesting! 1% or 2% interest is down right boring! Where this becomes exciting is when you can get higher returns from investments like stocks and mutual funds. For example, if you own $1000 worth of a stock and the price increases by 10% you have a value of $1100, an increase of $100. Any future increases are based on that new value. If it increases another 10% the new value would be $1210, an increase of $110. This is compounding returns. This also work in reverse when the values go down. When prices are decreasing the compounding is both a blessing and curse in my opinion. Using the same example, if you own $1000 worth of a stock and the price decreases by 10% you have a value of $900, a decrease of $100. Any future decreases are based on that new value. If it increases another 10% the new value would be $810, a decrease of $90. I...

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