Lessons of Compound Interest: Compounding Frequency

Yearly Really Beats Never!

You don’t get compound interest if you never reinvest, and the difference between never and yearly reinvestment is huge!  Increasing the reinvestment frequency is always a bit better but if you are already reinvesting monthly there just is not that much more to gain.

Don’t Forget!

You don’t want to forgo compounding because you forgot to reinvest- so why not look into automating the process?  Are you receiving dividend checks or are they going to a money market account?  How long does that money sit before you invest it?  Does it ever get reinvested at all?  There are automatic options called Dividend Reinvestment Programs (DRIP).  These programs re-invest the dividends as soon as they are paid out and usually do so with very low transaction costs.  It’s easy to sign up for a DRIP but the enrollment process varies between brokers.  For example E*Trade has an online form to enroll your stocks- while Ameritrade requires a call their customer service to enroll your stocks.
If you have a CD Banks are usually happy to automatically reinvest a CD into another CD of the same term. Just make sure that you know what time frame you could withdraw without a penalty.

Shopping Time

If you have to delay reinvestment a week or so won’t make much of a difference in your overall return- but higher rates of return will.   Take a bit of time to shop around for better alternatives.  The internet is a great resource for comparison shopping for investments.  I found a lot of sites by searching “compare CD interest rates”.  Keep in mind that as long as you are under the FDIC limits any FDIC insured bank is just as safe.
If you invest in ETFs or mutual funds it is a good idea to check that the fees haven’t changed or that there aren’t other lower cost alternatives.  Again all of this information is available on the internet- for example if you own a Vanguard EFT the prospectuses are available here.  I found that page searching “Vanguard Prospectus”

Leave a Reply

You must be logged in to post a comment.