![]() If you have a 20% return with each trade, after five trades that $500 has grown into $1,244. The table below summarizes how much you would have after each trade. Let’s say you make another 20% ($120), which means you would have $720 to invest in the next trade. To maximize your earning power you invest the whole $600 into another option trade. When it comes to options, compounding can really amplify returns.įor example, you start with $500, buy an option and sell it for a 20% gain ($100). This is why investor appetite has returned for riskier assets-like stocks and options. With the interest rate so low, you are barely going to earn a return for investing in fixed income. Realistically, in today’s ultra-low interest environment, you wouldn’t be able to get 3% for a CD, but the point stands. I chose a high interest rate to accentuate the effect of compounding. ![]() The 3% interest on the annual interest you earn over the 5 years is what accounts for the extra return. And each year, you earn 3% on a higher starting amount because of interest received from the year before. This means in Year 2, you would actually be earning interest against $1,030, not the original $1,000. ![]() It will be higher.Īs the table shows, at the end of Year 5, when the CD matures, you would get back $1,159.27, for a 15.9% return.Īt the end of Year 1, the bank pays you $30 in interest so your CD is worth $1,030. At the end of 5 years, your total return won’t be 15% (3% x 5 years). Let’s say you invest $1,000 in a 5-year CD that pays you 3% interest, compounded once at the end of each year. Compounding, when you reinvest the principal plus any interest and gain, is a powerful force in investing.
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