As a secretary at Abbott Laboratories, Grace Groner never really earned an amazing salary. She lived in a modest one-bedroom house in Lake Forest, Illinois. She didn’t own a car, and she could often be found at local rummage sales.
So how did this humble secretary amass a fortune of more than $7 million?
A Simple $180 Investment in Company Stock
After graduating from her local Lake Forest College in 1931, Groner found a position as a secretary at Abbott Laboratories. She continued to work for this health technologies giant for more than 40 years.
In 1935, Groner was offered the opportunity to purchase company stock. She purchased three shares for a total sum of $180 (approximately $3,440 in today’s money). While this was no small sum back in this time, the investment paid off handsomely.
Groner held onto her shares over the decades. When those shares would split, she’d simply reinvest the dividends each time.
By the time she passed away in 2010, her original three-share purchase had transformed into 100,000 shares of Abbott stock (valued at a staggering $7.2 million).
How Compounding Interest on Investments Works
Compounding is arguably the fundamental way investors build wealth over time – and it requires the least amount of effort. Instead of seeking short-term appreciation through actively buying and selling stocks, ETFs or mutual funds, compounding leverages securities by automatically reinvesting interest and dividends for the long-term. Thus, investors are effectively collecting interest on top of interest.
While Groner's shares grew at an exceptional annual average of 14.97% over a 75-year period, this rate is not typical of a compounding interest strategy. However, through smart management and continual reinvestment, you can use compounding interest to your advantage by driving long-term wealth with less stress.
Simple Compounding Interest Examples
Building your shares over time through compounding interest translates into an increased dividend year over year and hopefully continued capital appreciation. By putting those dividends back into an investment, you are compounding your earnings (or earning interest on the interest you have already accrued).
How to Grow a $200 Investment at 6%
As an example, let’s say you purchase 10 shares of a relatively stable, dividend-paying stock for $20 per share. On average, that $200 investment pays an annual return of 6%. If the company kept up its financial performance, the stock would pay roughly $12 in dividends and capital appreciation by the end of the first year.
If you reinvested the dividends, your investment would potentially grow like this:
How to Grow $10,000 at 5%
What if you invested even more money and followed the same strategy? If you started with a $10,000 investment on a stock that earned a 5% annual return – then reinvested them over a period of 30 years – this is how your money could potentially grow:
It’s important to note that – when investing in company stock, ETFs, or mutual funds – dividends are never guaranteed and your investment may lose value. While compounding interest can help you build wealth over time, it’s equally important to continually monitor your investments and read prospectus statements to determine whether holding a certain investment for the long-term to capture compound returns is still right for your situation.
Why Investors Love Compounding Interest
The beauty of dividend compounding is in its simplicity. Instead of managing option trading or rebalancing portfolios, dividend compounding takes the money you have already earned and puts it back to work.
In the above examples, the hypothetical investors grew their money simply by using their dividends to purchase even more shares. In turn, the additional investments earned more interest, which turned into greater returns – all without any active changes to their accounts.
In the above example, compounding $200 over 10 years yielded $160 in returns for the investor. While it may not seem like much, imagine the effect of compounding with much larger balances, longer periods of time, and faster growth rates.
How to Reinvest Your Dividends
Thanks to technology, reinvesting dividends is a very easy and automatic process. If you are using an online investing platform, most will allow you to click a checkbox to select the option to reinvest dividends.
Note: Depending on your investment selection, be aware that choosing to reinvest dividends can cause your portfolio to drift from your intended allocation.
If your portfolio or retirement account is managed by a financial professional, they may automatically reinvest the dividends or instead can use the cash from dividends to rebalance.
How to Turn $1,000 into a Million Dollars
Now that you understand how compounding works, how can you maximize it to its full potential? Is it possible to turn $1,000 into a million dollars?
It’s plausible, but it requires discipline through regular savings. While putting aside $100 every month may not seem like a tremendous amount of money, a $1,200 annual investment at just 6% a year can make your money grow to over $100,000 in 30 years' time.
What would happen if you were to extend that over 30 years? By investing $36,000 ($1,200 x 30 years) instead of spending it, you could earn an extra $64,000 without putting extra hours in the office.
While $36,000 over 30 years is great, putting away a little more could help you get closer to your goals. If you invested $400 every month in an investment that provided a 6% return, your investment dollars could potentially grow to nearly $800,000 within 40 years.
Curious as to how much money you could grow through compounding? Chart out some situations and create a plan using our Compound Savings Calculator.
The Disadvantage of Compounding
Although compounding returns looks easy, compounding takes a long time to build momentum. Over the first few years, you may not see major returns from reinvesting dividends because you’re building up your share ownership.
Think of compounding as if it were a tree: In the beginning, saplings will need time to grow their trunk and expand foliage. With constant care and regular pruning, that tree will grow bigger, providing fruit as a reward for hard work.
Just like the tree takes years to bear fruit, a compounding strategy takes time to grow a small investment into a large fund. The more years you compound returns, the larger your investment will probably grow.
Take Your Compounding Savings to the Next Level
A healthy compounding strategy can unlock doors financially, helping you build wealth over time. Because compounding is a long-term strategy, it’s important to continue reinvesting dividends (and relying on capital appreciation) instead of taking cash out.
As you think about your goals, consider why you want to start compounding, as it could affect your strategy. Building a retirement fund requires a different strategy than building a college fund as they have different time horizons. However, both rely on the magic of compound interest. Moreover, your goals will determine when you should withdraw your compounded earnings.
How to Build a Compound Savings Fund
Start by determining your timeline. While a retirement fund or general savings fund can take 40 years or more to build, a college fund has less time to mature. Setting a time span can help you decide on which types of investments make the most sense for your needs.
Once you have a goal and strategy in place, create an exit strategy on how you’ll use the money. Reaching your time goal doesn’t mean it’s time to deplete the savings entirely. Retirees often prefer to shift investments into high-dividend earning funds to help them keep earning interest – even as they take money out and move more of their portfolio into bonds.
It’s always important to have emergency savings, but your money set aside for the long-term shouldn’t be used for it. In the event you need cash, always draw from a high-yield savings or money market account first. Taking long-term savings for a short-term emergency hurts you twice: Not only are you losing out on compounding interest, but it will also take time to re-earn what you would have gained.
What Should You Do with Your Compounded Savings?
Because building compound savings is a marathon (and not a sprint), you’ll have plenty of time to determine what you want to do with your nest egg. Many people start building wealth through compound savings to leave a family inheritance, create a legacy for charity, or simply save towards major life expenses.
For Groner, she endowed her funds to her alma mater to support internships, international study, and service projects. With discipline, determination, and a goal, there’s no limit to the good your compound investments could do well into the future.
- Create a retirement savings goal
- Design an investment plan to reach it.
- Get a professional money manager to continually monitor and rebalance your portfolio
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