Compounding guide

Five areas where compounding can affect you:

Step 1

Interest on your bank account

Banks pay interest on the money you hold with them. This increases the value of your account balance. Then you get some more interest on the increased amount, and so on.

Step 2

Interest on credit cards

Any debts you have will also incur interest, and this interest is added to your debt. If you don't pay your debts off, the interest next time around will be applied to the increased amount of debt. And guess what? The interest rates here are higher than they are on your bank account – so things can quickly get out of hand.

Step 3

Mistiming the market

If we could always be invested when the market goes up and be out of the market when it goes down, we would all get rich quickly. Unfortunately, however, it's not that simple. All too often, investors get out of the market after it's gone down, and don't get back in until after it's started to recover. This common investing mistake locks in losses and misses out on significant gains. And when you compound those effects over time, it makes a big difference.

Step 4

Adding to your portfolio

Conversely, if you make regular, modest additions to your portfolio, the long-term effect of those small amounts can really accelerate you towards your goals.

Step 5

Costs

Just like interest and investment returns, costs compound over time. An extra percent here and there might not seem like much. But, over time, those small amounts will really add up, and they can make a massive dent in your investment goals. So, control costs early, or count the cost later.