Investment returns will vary year to year and even day-to-day. In the short term, investments such as stocks or stock mutual funds may actually lose value. But over a long time horizon, history shows that a diversified growth portfolio can return an average of 6% to 7% annually.
Compound interest can help fulfill your long-term savings and investment goals, especially if you let it go to work over several decades.
Example of Compound Return
For example, suppose you started with an initial investment of $1,000. If you multiply 1,000 by 1.1 five times, that is, $1,000 x (1.1)5, you will end up with about $1,611. If an investment of $1,000 ended up being worth $1,611 by the end of five years, the investment could be said to have generated a 10% annual compound return over that five-year period.
Here is a calculation example:
- Year 1: $1,000 x 10% = $1,100
- Year 2: $1,100 x 10% = $1,210
- Year 3: $1,210 x 10% = $1,331
- Year 4: $1,331 x 10% = $1,464.10
- Year 5: $1,464 x 10% = $1,610.51
However, this does not mean that the investment actually appreciated by 10% during each of the five years.
When you invest in the stock market, you don’t earn a set interest rate. Instead, the return is based on the change in the value of your investment. When the value of your investment goes up, you earn a return.
If you leave your money and the returns you earn invested in the market, those returns are compounded over time in the same way that interest is compounded.