The Magic of Compounding

Another way that your money grows in a mutual fund is through compound growth that results when you reinvest the income. If a fund pays you a dividend and you use the dividend to buy more shares, you'll earn even more the next time around; you'll receive dividends on your original investment as well as on the additional shares. Compounding can work wonders on the value of your investment, especially over long periods of time.

Take an initial investment of $10,000 earning an average of 9% each year for 10 years and withdraw your earnings each year instead of reinvesting them. You'll have $19,000 at the end of 10 years ($10,000 initial investment + 10 payments of $900). Take the same investment and leave the annual earnings in the account to compound, you'll have $23,674, or nearly 25% more.

Compound growth also works dramatically if you invest on a regular basis. If you were to invest $200 each month for 10 years ($24,000 in all), earn an average of 9% per year and reinvest your earnings, you'd wind up with $38,703.

This chart shows the dramatic difference in the value of an investment when dividends are reinvested rather than paid to you in cash.

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