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Compounding Investment Returns

Whether you're investing for retirement, higher education, or a new home, knowing how quickly your investments may grow will help your decision-making process. Reinvesting, or compounding, your earnings can make a big difference in your investment account's growth.

What is Compounding?

Compounding occurs when you reinvest your earnings and/or dividends in the fund. You may not see the benefits of compounding right away but account growth can gain momentum as earnings begin to accumulate.


How the Rule of 72 Works

  1. Find the estimated rate of return for your investment. You can get an idea of what an investment's average returns are by looking at how well it has performed previously. Unfortunately, past performance doesn't guarantee future results.
  2. Divide 72 by your estimated rate of return. For example, money invested in a fund with an estimated return of 6% may double in 12 years (72/6 = 12).

Using the Rule of 72, the chart below shows you how compounding might play out over a 20-year period with a $1,000 investment. We used a 6% estimated rate of return.

Years Invested and Ending Balance

Hypothetical Illustration
Year 1- $1,060Year 11- $2,011Year 21- $3,603
Year 2- $1,124Year 12- $2,132Year 22- $3,819
Year 3- $1,191Year 13- $2,260Year 23- $4,048
Year 4- $1,262Year 14- $2,396Year 24- $4,291
Year 5- $1,418Year 15- $2,540Year 25- $4,548
Year 6- $1,503Year 16- $2,692Year 26- $4,821
Year 7- $1,593Year 17- $2,854Year 27- $5,110
Year 8- $1,689Year 18- $3,025Year 28- $5,417
Year 9- $1,790Year 19- $3,207Year 29- $5,742
Year 10- $1,897Year 20- $3,399Year 30- $6,087

The illustration above is intended to show the principle of compounding. This hypothetical chart is for illustrative purposes only and doesn't represent any specific type of investment. It doesn't include the impact of expenses or fees, which would have reduced the results of the illustration.

As you can see, compounding made a small difference in the ending balances during the early years. However, as more earnings were added, compounding made a significant difference over time. Remember, this is a simplified example.


Saving Early is Important

Time can be on your side. Saving for retirement early might make a dramatic difference in reaching your financial goals. In the example below you can see the difference an early start makes. Remember, this is a simplified example.

Hypothetical Illustration

holder

Mary Susan
Started Investing At: age 25 age 45
Yearly Contribution $5,000 $5,000
Number of Years 10 years 20 years
Total Contributions $50,000 $100,000
Rate of Return 6% 6%
Value of investment at age 65 $425,304 $206,661

This hypothetical example of compounding is for illustrative purposes only and does not represent any specific type of investment. It does not include the impact of expenses or fees, which would have reduced the results of the illustration.

Risk Disclosures

Neither State Farm® nor its agents provide tax or legal advice.

Securities distributed by State Farm® VP Management Corp.

Investing involves risk, including potential for loss.

Securities are not FDIC insured, are not bank guaranteed and are subject to investment risk, including possible loss of principal.

AP2019/08/0850