Compound Annual Growth Rate

Mutual funds are beneficial in many ways one of which is through compounding. This means that once you are paid dividends you reinvest them in the mutual fund. As a result, the reinvested dividend is used for the purchase of additional shares, which leads to further profits on the subsequent dividend paying. Since you have increased the number of shares you hold by purchasing additional shares by the dividends, you will have returns on your initial investment and the newly acquired shares. Compound growth is especially beneficial over the long term.

To illustrate the wonders that compound can create in financial terms over long periods of time, imagine that you have initially invested $15,000 on which you earn 10% each year for a ten-year time period. In the first case you withdraw the earnings you have made. Thus, at the end of the ten-year period you will have $30,000 ($15,000 initial investment plus 10 payments of $1500). In the second case you have decided to reinvest your dividends and benefit from compounding. As a result you will end up with approximately $38,906, which is around 30% more.

The strength of compound is further increased by the regular invest as for example if you make monthly contributions to your account.

So, when dividend paying time comes, carefully consider whether you will withdraw your earnings or leave them and enjoy the fruits of compounding.

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