Lesson 04 of 04
Interest that earns its own interest
Compounding means each period’s growth is calculated on a larger base. The formula is simple. Applying it to stocks is not.
Keep these
- Annual compounding multiplies by (1 + rate) once each year.
- The rule of 72 is a rough doubling shortcut, not an exact law.
- A bank example uses a stated rate. A stock does not owe you one.
The lesson
If a balance grows at 10% a year and nothing is withdrawn, year one adds 10% of the start. Year two adds 10% of the new, larger balance. That second step is the whole idea: growth applied to previous growth. After n years of annual compounding, multiply the start by (1 + rate) to the power of n.
The rule of 72 divides 72 by the percentage rate to estimate how many years a doubling takes. At 6%, it suggests about 12 years. It is a napkin calculation. Different compounding schedules change the exact answer.
The rate in the lesson is a teaching number. A savings account can quote a rate. A share cannot. Companies cut dividends, prices fall, and a bad year is not “interest” you are owed. Use the formula to understand growth. Do not paste a hoped-for stock return into it and treat the result as a plan.