Compound return is achieved when you invest a sum of money at a particular rate of return. Instead of taking out the interest earned after a year, you add it back to the principal sum and reinvest this larger sum.
So the next year, the rate of return is on a larger principal sum. This continues until the returns a year become greater and greater!
For example, say you invested $100 into a stock that gave you an annual return of 20%. At the end of one year, you would have $120. Instead of taking out the $20 profit, you leave it inside for another year at the same 20%.
At the end of the second year, your investment would grow to $144. The next year, it would grow to $172.80 and on the fourth year, it would grow to $207.36!
Albert Einstein, the greatest genius of our time once remarked that compound interest was the greatest mathematical discovery ever made!
He came up with a formula called the Rule of 72. It states that if you take 72 and divide it by the Annual Percentage return, it will give you the number of years your investment would double!
For example, in the previous case, the percentage return was 20%. So if you take 72 / 20 = 3.6 years you will see your investment of $100 double to $200 in 3.6 years.
The power of compounding was Warren Buffett's secret weapon in creating the second biggest fortune in the world, purely by investing in US stocks.
Warren achieved an average annual return of 24.7% for 49 years! This means that is money doubled every 2.9 years (72 / 24.7). He turned an investment of $100,000 in 1956 into $4,200,000,000 ($4.2 billion) today.
You may be thinking that a 12.08% annual return from the stockmarket is small. However, when allowed to compound over a period of time, it will turn small amounts into huge returns!
Again, imagine if you were to earn an average of $3,000 a month for your entire working life of forty years. If you were to just invest 10% of your in-come a month (i.e. $300) into the US stock market and allowed it to compound at 12.08%, how much would it grow to?
Using a financial calculator, you will see that $300 a month invested at 12.08% will grow to $3 million! And that's just from investing $300 a month.
If you could invest $1,000 a month at 12.08% (I am sure you can easily create this additional in-come stream), it will grow to $10.02 million!
The only question is when are you going to start investing and compounding your way to lifetime wealth.