Definition of Compounding

Definition of Compounding

Compounding is the process where the value of a smart financial commitment increases because of the earnings on a smart financial commitment, both capital gains and attention, generate attention over the years.

Brief Explanation of Compounding

This rapid development occurs because the overall development of a smart financial commitment along with its major generates cash in the next interval. This differs from straight line development, where only the major generates attention each interval.

The more Compounding periods effect in a higher finishing future value of the financial commitment. This phenomenon, which is a direct realization of that period value of cash, is also known as compound attention. For example, suppose a $10,000 financial commitment in Company X generates 20% the 1st season. The complete financial commitment is then worth $12,000. Next, believe that in the second season, the financial commitment generates another 20%. In season two, the overall balance of $12,000 would generate 20%, finishing with a value of $14,400 instead of $14,000. The extra $400 of development is due to the $2,000 earning of the season one also growing at 20% in season two, along with the major. Assume a one-year period of time.


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