Compounding Interest Explained
Compounding interest explained in simple terms. Learn how your money grows over time, why starting early matters, and how long term investing builds wealth.
What is compounding interest and how does it build wealth over time?
Compounding interest is when your money earns returns on top of returns, creating exponential growth over time. A simple example: €1,000 invested at 7% annual return becomes €1,070 after year one, then earns 7% on the full €1,070 in year two (€1,145), and keeps accelerating from there.
This "interest on interest" effect is why starting early—even with small amounts—beats waiting for a bigger starting balance later. It's the closest thing finance has to a superpower.
How compounding actually works
The basic math (don't worry, it's simple):
If you invest P (principal) at rate R over T years, compounded annually:
Future Value = P × (1 + R)^T
Real example:
€100/month invested at 7% average return (typical for diversified stock ETFs):
10 years: €17,531
20 years: €49,000
30 years: €103,000
The same €100/month for 20 more years (total 30) ends up with 6x more than 10 years alone. Time doubles, results explode.
Compounding in saving vs investing
Savings accounts: Compounding works, but rates are low (1–3%). €100/month at 2% over 30 years = €41,000. Safe, but inflation often eats most gains.
Investing: Higher expected returns (5–8% for balanced portfolios) make compounding powerful. That same €100/month at 7% hits €103,000 over 30 years. The extra 4–5% return difference creates massive divergence over decades.
"Time is the most powerful force in investing. A 10% return compounds to extraordinary wealth over decades." – Warren Buffett
Why trade & tonic investors benefit
Compounding only works if you stay invested through market cycles. trade & tonic helps by giving you a clear, explainable analysis on your holdings or ETFs showing if fundamentals support holding through volatility, or if risks warrant rebalancing.
Pro move: Use regular €50–€200 contributions to low-cost, diversified ETFs. Let compounding handle the rest while trade & tonic stress-tests your core positions.
TL;DR: Compounding turns small, consistent investments into serious wealth—but only if you start now and stay invested. €100/month at 7% for 30 years = €103K. The earlier you begin, the less you need to save monthly to hit big goals.