Compounding on index funds?

Google GnaSkItSlf
Mar 11 11 Comments

I need a little help here understanding the idea of compounding when investing on index funds. I understand what compounding is in general but to me, it only works if you get interest deposited on your sums periodically so you could gain interest on interest as well. But if I had invested in let's say NASDAQ ETF like ONEQ 5 years ago, my stocks would have grown by 84% but that wouldn't have any compounding. Value of the stocks is just 1.84 times what it was in 2014. So I'm confused how investing in index adds compounding value?

P.S.: obviously not considering dividends here.

comments

Want to comment? LOG IN or SIGN UP
TOP 11 Comments
  • This comment was deleted by original commenter.

    • Chase DaimeJimon
      he is not incorrect. He is being literal, so unless he realizes his gains and reinvest he wont consider compounding. However, it is market practice to close per fiscal year and reset on yearly basis.
      Mar 11
    • Google GnaSkItSlf
      OP
      Ok is it fair to say the value of index fund shares increases exponentially then? 1.07^10=1.97 so 7% yearly doubles in 10 years?
      Mar 11
    • Charles Schwab / Productmilkdud
      You just discovered the rule of 70 (aka rule of 71, 72). Take 70 divided by your growth rate to find approximately how many years it will take to double the principal.
      Mar 11
  • Chase DaimeJimon
    No, take it anually. So you invest x, and your money annually grows at x rate. The more times you get this experiment going the best return. ex: (1+0.84) = (1+0.3564)^2 = (1+0.129701)^5 = (1+0.03095)^20. So what does this actually means? The more time you have for money to grow, the less you will need to achieve wealth, thats the magic of compounding. Now if you are someome that considers yearly investment periods you could liquidate your etf or index fund into another and keep changing the expected return year by year. Thats where also the compounding could be appreciated. Remember, this is the long run, and returns over year have distributions.
    Mar 112
    • Google GnaSkItSlf
      OP
      But the # of shares remains the same if I dont sell (which is taxable) so it wouldn't compound.
      Mar 11
    • Chase DaimeJimon
      When you change from one inv to other you compound on units. But as your are stating, technically, unless you dont get "paid" you wont get a "interesting or winnings making money". Unless you do a "fiscal year" account in your investments.
      Mar 11
  • Microsoft shared_ptr
    lol, dividends are the key to compounding. You compound on the interest made... you reinvest your dividends.
    Mar 111
    • Google / Enggit5
      Not only. Internal compounding (cash reinvested internally by companies) is also a big driver of growth
      Mar 11
  • Google GnaSkItSlf
    OP
    You are explaining compounding which as I said I understand. But I look at it this way: the number of shares i have doesn't change. e.g. 5 years ago, I bought 10 shares with price of $100 each. If by the end of year price goes up to $107 (7%), I still only have 10 shares. Also the next year and so on. And at the end of 5 years, I still have 10 shares with whatever price it has and not compounded.
    Mar 112
    • Google / EngSexIsLove
      I think what they are saying is the price of an index fund is expected to grow exponentially.
      Mar 11
    • Google GnaSkItSlf
      OP
      That makes sense then. Since 1.07^10 meaning 7% yearly for 10 years is 1.97 which means almost double your initial amount.
      Mar 11

Join verified employees in our anonymous social network!Download the app!

close