One of the most powerful investing concepts is compound interest. Simply put, it refers to the process of earning potential returns not only on your initial investment but also on any accumulated returns—which can help grow your investment over time.

How does compound interest work?

Need help understanding compound interest: Learn more about compound interest with the following example.

Imagine you invest $1,000 at a 6% annual return. An annual return is the percentage of profit or loss your investment makes in a year, which can help give you a clearer picture of how well your money is performing. In the first year, you earn $60, increasing your total to $1,060. If you reinvest this return, the next year, your 6% return is calculated on $1,060, earning you $63.60 and bringing your total to $1,123.60. As this cycle of reinvesting and earning continues, over time, growth may become exponential.

By year 30, with the same 6% return, your annual earnings would be $325.10, a significant increase from the initial $60. That's more than five times the $60 return you earned the first year just for sitting by and letting your money grow.

This scenario is hypothetical and provided for informational purposes only. It is not intended to represent any specific investment, nor is it indicative of future results. All investing involves risk, including the possible loss of principal.

Want to dive deeper into the math? The formula for compound interest is A = P(1 + r/n)nt where:

• (A) is the amount of money accumulated after (n) years, including interest.
• (P) is the principal amount (initial investment).
• (r) is the annual interest rate (decimal).
• (n) is the number of times that interest is compounded per year.
• (t) is the time the money is invested for in years. This formula can help you estimate how much your investment may grow over time.

Patience and reinvestment

Compound interest is created in slow and steady reinvestment of gains. To help maximize these benefits, consider reinvesting your earnings automatically. If you have these earnings, they add to the value of your account and boost the potential to earn even more.

Next, patience is key. If possible, resist the temptation to withdraw your funds as they grow. Instead, hang on to them as long as possible to maximize on compounding.

Remember: if your investments are in a taxable account, you will still owe taxes on the interest, dividends, and capital gains you receive, even if you reinvest them.

Making compounding growth work for you

Wondering how to use compound growth more effectively. The sooner you start saving and investing, the more time your money has to potentially grow. The earlier the better, though, it's never too late to start.

Try regularly adding money to your account. Many financial service providers offer automatic transfer options, making it easy to contribute routinely. Some employers also offer the option to split your direct deposit, allowing a part of your paycheck to go directly into your investment account. Keep in mind, a periodic investment plan does not assure a profit or protect against a loss in declining markets.

Compounding interest can be a powerful tool to help you reach your long-term financial goals. Learn more with tools and resources from Wells Fargo.

Investment products and services are offered through Wells Fargo Advisors. Wells Fargo Advisors is a trade name used by Wells Fargo Clearing Services, LLC (WFCS) and Wells Fargo Advisors Financial Network, LLC, Members SIPC, separate registered broker-dealers and non-bank affiliates of Wells Fargo & Company.