A $1,000 balance earning a steady 7% a year gains $70 in the first year and $74.90 in the second, without any new deposits. The rate stays the same. Where does the extra $4.90 come from?
That extra $4.90 came from the first year's earnings. With a $200 monthly investing habit, new deposits join the gains along the way. A rising balance can come from saving more, earning a return, or both.
Earlier gains join the starting money
Compound interest is interest earned on both the original money and earlier interest. Each year's ending balance becomes the next year's starting point:
- Year 1. $1,000 × 7% = $70. The balance becomes $1,070.
- Year 2. $1,070 × 7% = $74.90. The balance becomes $1,144.90.
Of the second year's $74.90, $70 comes from the original $1,000. The other $4.90 is 7% of the first year's $70. The same rate earns more dollars because it acts on a bigger balance.
Simple interest uses only the original amount. At $70 a year, the same $1,000 would become $1,140 after two years.
Reinvestment means keeping investment income invested so it can contribute to future growth. A cash dividend is a payment from a company to its shareholders. Using that payment to buy more shares is dividend reinvestment.
A stock's return comes from price changes and any dividends. Those returns can compound when income stays invested, though a stock does not pay a promised 7% interest.
Separate deposits from growth
Start at zero and invest $200 at each month-end, leaving everything invested. Say the balance grows at a steady 7% a year. All amounts are US dollars, before fees and taxes and without adjusting for inflation.
Each month, the balance grows first. The next $200 arrives at the end, ready to start earning the following month.
After one year, you have put in $200 × 12 = $2,400. The balance is $2,476.06, so growth accounts for $2,476.06 − $2,400 = $76.06.
Why only $76.06, when 7% of $2,400 is $168? Most of the money was not there for the full year. Your first deposit earns for eleven months; the last arrives just as the year ends.
Early on, the biggest addition is your own saving. A deposit makes the account larger without being a cent of investment profit.
After 30 years, the balance reaches about $233,891. You supplied $200 × 360 = $72,000; the remaining $161,891 is growth. That includes earnings on your deposits and earnings on earlier gains.
Two starts, the same finish date
What if you wait ten years, then make the same deposits for twenty years? Both paths finish 30 years from the first start.
The later start adds $48,000 across 240 deposits and ends with about $101,507: $53,507 of it is growth. In each bar, deposits sit at the bottom and growth sits above them.
The earlier start supplies 120 extra deposits, totaling $24,000. During the final twenty years, both paths add exactly the same money. The gap comes from the first decade's deposits and all the growth they earn along the way.
The head start is both more money and more time. The later path still has twenty years of compounding; missing the first decade does not make the next two pointless.
What you can choose
Time, contributions and returns all change the result; none always matters most. With the same schedule and rate, $100 a month produces half the final balance of $200. A smaller contribution changes the scale, not how compounding works.
Change just the return from 7% to 3% and the 30-year balance falls to about $115,743. Your deposits are still $72,000. The difference comes entirely from how much the invested money earns.
The rate is easy to change in a calculator and impossible to order from a market. Actual returns vary and can be negative.
A simple average of changing yearly returns will not necessarily give the rate that reproduces your ending balance. Measuring returns takes that further if you want the arithmetic.
Your contribution has to fit alongside bills, emergency savings and expensive debt. Starting when money is available matters more than regretting a start you could not afford.
Optional: check the arithmetic
The opening example is one lump sum with no later deposits. A short formula does the repeated multiplying:
Here P is the starting amount, r is the annual rate as a decimal, and n is the number of years.
For $1,000 over two years at 7%, that is $1,000 × 1.07² = $1,144.90. The power of two means multiplying by 1.07 twice. Each monthly deposit needs its own time to grow, which is why this formula alone cannot total the $200 plan.
The Rule of 72 estimates how many years a balance needs to double through growth alone at a steady positive rate:
At 7%, 72 ÷ 7 gives about 10.3 years; the exact calculation gives about 10.24. Adding another $1,000 to $1,000 also doubles an account, but that is not the doubling this shortcut measures.
Those steady rates helped isolate compounding. Next, risk and return replaces them with uncertain outcomes and the losses your plan can bear.
In short
- Compounding means earlier gains can earn gains of their own.
- Your deposits build the account; they are not investment profit.
- Starting earlier adds both deposits and time in this monthly example.
- Time, contributions and returns all matter. A calculator lets you choose a return; a market does not.
- The Rule of 72 estimates doubling through growth alone, without fresh deposits.