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Definition of 'Compounding'

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Compounding is the process of earning interest on interest. When you invest money, you earn interest on your initial investment. This interest is then added to your principal, which means that you earn interest on the interest you have already earned. Over time, this can lead to significant growth in your investment.

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The power of compounding is exponential. This means that the longer you invest, the more your money will grow. For example, if you invest $100 and earn 10% interest per year, your investment will be worth $110 after one year. After two years, it will be worth $121. After three years, it will be worth $133.10. And so on.

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Compounding is one of the most important concepts in personal finance. It is the key to building wealth over time. If you want to grow your wealth, you need to start investing early and let your money compound.

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There are a few things you can do to make the most of compounding. First, invest as early as possible. The sooner you start investing, the more time your money has to grow. Second, invest in high-quality investments that have a history of generating strong returns. Third, make regular contributions to your investments. This will help you to dollar-cost average your purchases and smooth out the effects of market volatility.

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Compounding is a powerful force that can help you to build wealth over time. By understanding how compounding works and by taking steps to make the most of it, you can achieve your financial goals.

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