UnThreaded | Threaded | Whole Thread (2) | Ignore Thread Prev | Next
Author: TMFSelena Big gold star, 5000 posts Old School Fool CAPS All Star Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2209  
Subject: Re: Returns and Compounding=confused! Date: 4/22/1999 10:16 AM
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Recommendations: 0
<< I know this is a basic question but I haven't really found it explained so that I understand it. I understand the concept of compounding but don't understand how returns work.
>>

Well, they're not unrelated to each other. Let me try to explain. (If I misstate anything, someone please speak up.)

If you buy stock for $100 and five years later it's valued at $176, it's gone up 76%. You've got a 76% 5-year total return. You can annualize that, though, determining that you earned the equivalent of 12% per year to get the total 76%. Another way of thinking about that is that your investment earned a compounded 12% return over the period.

If your 12% return was not compounded (and now, we've moved further into the theoretical realm, and are not really talking about a specific stock you bought), then your $100 investment would simply earn the same 12% per year. 12% would mean $12 per year, for a total of $60 in five years and a total end result of $160 -- a total 60% return.

You're right, that in a sense, compounding is continual reinvesting, and by holding your stock for the long term, you're not selling and rebuying it. But you can still think of your returns in compounding terms. It's a way of visualing/conceptualizing how money grows.

Because if you started with $100 of a stock and now it's worth $150, if it goes up 3%, it's going up 3% from $150, not from your initial $100. Your base keps growing. In a sense, compounding is at work.

(I fear I may have created more confusion instead of clarifying things!)

Cheers -

Selena
Post New | Post Reply | Reply Later | Create Poll Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (2) | Ignore Thread Prev | Next

Announcements

Pencils of Promise - Back to School Drive
"Pencils of Promise works with communities across the globe to build schools and create programs that provide education opportunities for children."
Post of the Day:
Macro Economics

Russia Collapsing Again?
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement