Where does compounding come in?

I have been investing in a portfolio of 7 shares for over 1.5 years. I invest 200 Euros every month. After 25 years and an investment of 60000 Euros, I received a projection of over 1.5 million (Est. based on 20% annual return).

However, I don’t understand where the compound interest comes in. I haven’t sold anything yet and don’t plan to. So, I want to know - how do 60000 Euros worth of investment over 25 years make it to over 1.5 million if I am not selling and reinvesting the profit?

I know this might be a stupid question, but I major in CS and have very little experience with finance.

I assume your projections are based on the app projections; which are based on past performance. You would need a return of 22% to reach that assumption, which is not attainable.

A more likely outcome would be below. It would take 50 years for your €200/month to reach 1.5M in this scenario.

You would be expecting to be at around €5,000 at the 2 year mark in this scenario (in a perfect world).

To answer your question, compounding is best seen near the end. But a good milestone is that the interest (growth) on your investments will start exceeding your contributions in year 10.

Currently, my return on investment is 1738.03 Euros. When people say interest on return - Do I have to sell the shares worth my return and re-invest or just keep them as it is?

This is the part that confuses me the most!

Just keep them as is. Expected return of around 8% means €1000 becomes €1080(€80 gain). Then €1080 becomes €1166 (€86 gain). Then €1166 becomes 1260 ($94 gain).

Your gains increase your portfolio value, then new gains are compounded on the new portfolio value. This process keeps getting exponentially faster.

Thank you so much for explaining - now I get the gist of it :slight_smile:

Hi. Just to add another explanation of how compounding works. Imagine I put in £100 and just leave it with an annual interest rate of 10%.

Year 1 => £100 + 10% = £110
Year 2 => £110 + 10% = £121 so you got £1 more interest because you got 10% on the previous year’s interest as well (it compounded).

Year 3 => £121 + 10% = £133.10

The maths with a single amount are very simple and the effective interest rate over n years is 1.10^n so if you left the £100 for 10 years the total you’d have would be £259.37 and over 25 years it would be £1083.47

Personally I would not believe the 20% return figure.

Thank you - I know 20% is just estimated. I was just confused as to year 2 starting with $110 when I haven’t taken out and re-invested the $10 I got from year 1.

I didn’t take into account the increase in the value of the portfolio.

I can understand some confusion.

Another way to think about it is look at daily share prices. If a company share price is $100 and it goes up by 1% then the next day it will open at $101. You don’t need to have sold the shares they are just worth $101 on open on the second day. If the share price changes by X% on the second day that is the change on the current price (so 101 not 100). So after 100 days the price may be $105 and if it goes up by 1% again that day it is $106.05 at open the next day. The change is applied to the current price not the original price. You haven’t sold the shares or re-invested or anything (putting aside the issue of dividends).

Thank you for explaining - I was indeed looking at the picture from the wrong side. I overlooked the increase in share value!

Please do not plan life decisions or your retirement on a 20% figure, assume a 5-10% figure and map out the different scenarios at every % or 2.

At 5% make sure you can live and cover all needed costs and ideally some left over for extra. Then at 7-10% return if you make that you will then be very comfy.

The risk is if you aim high and make large decisions on that then you may run into big issues later. For example people who over estimate their returns will often contribute less, but the best way to guarantee compounding helps you is to contribute more, sooner.

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Thanks - I am not making decisions based on 20% - I just used it because it was in the projection! I am planning to keep investing every month, maybe a bit more than now but I will keep it going!

May I ask, what is your portfolio?