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Some Truths about Compounding

Compounding is the process whereby reinvested returns result in the investment earnings increasing exponentially over time. A simpler definition might be: "when you earn interest on your interest." Over time, you earn not just on your original investment, but also on the earnings themselves. This is the basis for the idea that if someone forgot about $5 in a bank account during the Civil War, today it would have grown to millions due to compound interest. The chart below shows how geometric growth looks. Notice the line is not straight, but curved, and the curve becomes increasingly pronounced. This is called the "hockey stick."

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