This post is explaining in detail how our investment calculator works. However the information is pretty much valid for any compounded investing. So even if you aren’t using the calculator the concepts on this page will help you understand how compounding works and when it works best.
Is obviously the sum you start with. If you are opening a bank savings account, this is the amount that you put in at the beginning.
This is the amount of cash you add to the investment per year. While you may be adding it during the year, the calculator will assume it’s added at the end of the year. So the current annual contribution is not considered when calculating profits for the current year. This is most similar with the real life situations where you start earning interest after the current investment period ends.
This setting obviously defines whether you’ll leave all your profits in the investment (so they are added as balance for the next period), or you want to cash some of the profits in your pocket and spend them for something else. Later below you’ll see how big impact this may have on your overall result.
So, let’s have a look at the results table shown after you hit the calculator’s Submit button.
Balance At The End
Shows the balance at the end of the year. It comes from this equation:
previous balance + annual addition + interest earned – cash withdrawn
This is because everything adds up to your balance for the next year except the cash you put in your pocket.
The Contribution column just shows how much you add, so let’s move on the next.
The interest earned in cash is based on the balance at the start of the investment period and the % interest.
$ interest earned = (balance at the beginning) * ROI/100
This is where things can become more interesting. If you choose to compounding anything less than 100% of your investment you will be able to cash out part of the profits. Regardless the fact that you cash out same % every year, the dollar value grows because your principal/balance grows.
cash = interest earned – (100 – % compounding)% of interest earned
% Total Return
This is basically the ROI of your investment. You’ll see how with high % of compounding the total ROI grows really fast. Even if you withdraw anything less than 100% of your profits, the ROI will be bigger each year. For long investment periods compounding can do wonders.
At the bottom you’ll see figures that will help you make your long-term decision. The higher the ROI is, or the higher the compounding percentage is, the higher will be your end balance. On the other hand if you want money on hand you’ll prefer to withdraw some.
If you contribute some amount annually you’ll see something interesting. The % total return at the end will be lower than if you don’t contribute! Confusing at first, but this is absolutely correct. Because you add amounts later in the game they are unable to earn as high ROI as the amounts added earlier. So the total ROI in % is lower. But don’t get misled – adding cash to your investment doesn’t make it worse. Just look at the balance and the interest earned in dollar value and you’ll see they are much bigger when you add each year. This is what really matters.