Imagine a snowball rolling downhill.
As it gains momentum, the ball gets bigger and bigger.
This is exactly how compounding works.
In the investing world, the “snowball effect” describes how a small sum of cash can turn into a much larger amount over time.
What is compounding?
Picture this. You and your friend each have 1,000 dollars deposited in a bank account.
The account returns an interest of 5% a year.
Your friend decides to withdraw the interest every year for 10 years while you decide to keep your thousand dollars in the bank for the same period of time.
Your friend will earn S$50 interest every year. By the end of 10 years, he or she would have accumulated S$500 in interest.
Assuming this sum was reinvested instead of withdrawn, here’s how much you have earned over the same period of time.
After 10 years, you would have earned S$628.89 and ended up with a total of S$1,628.89.