Compounding on index funds?
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.
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.
But the # of shares remains the same if I dont sell (which is taxable) so it wouldn't compound.
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.
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.
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.
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?
Its the value of index fund that compounds, and if you can do DRIP and DCA,you earn a solid margin of safety on top and compounding escalates
lol, dividends are the key to compounding. You compound on the interest made... you reinvest your dividends.
Not only. Internal compounding (cash reinvested internally by companies) is also a big driver of growth