Compounded earnings occur when the gains from investments like interest earned from bonds or a the certificate of deposit (CD) -is added to the initial amount, allowing your funds to increase in value in time.

Here’s an easy example:

If you put the sum of $5,000 in an account with a five-year term, which has a 5-percent annual interest amount with no compounding you’ll get $250 annually which would result in six,250 over the course of five years. If the interest compounded each year, you’ll get $250 the first one year. You’d earn $262.50 for the following year, $275.62 in the third, $289.40 in the fourth in the fourth, then $303.87 at the end of year fivewhich would total $6,381.41 by the end the period.

Now, change the frequency of compounding from monthly to monthly Your total will increase just a bit in the range of $6,416.79. The interest rate is increased to 6percent then it increases even higher into $6,744.25.

However, the true magic happens as time passes. If you make a commitment of $5,000 each annually to forty years at an annual rate of 6% compounding the total will increase to a staggering $825,238.42. The earlier you begin earning, the higher your income could generate more income and that’s the real potential of compounding.