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Compound interest on stocks

PostPosted: Fri Mar 07, 2008 9:09 am
by kbro2699
Hi everybody! I am a long time lurker of this site and finally got up the nerves to comment/question.

I have limited investment knowledge and was hoping you guys could help me.

When investment sites and other places do hypothetical rate of return on stock market investments, they usually use a theoretical rate of return with compound interest. I have always wondered why or how a stock investment would return compound interest.

Evaluating the shape of the curves on the following charts,I can see that the stock market does tend to follow a compound interest profile, but I don't know why.


Basic Compound Interest Calculation

If I buy 7 shares of GSPC, I always have seven shares of stock (unless my stock splits, which doesn't necessarily occur at regular intervals). How will the returns compound unless I get more shares from the return, rather than just a higher stock price of my 7 shares.

Is the compound calculation used due to assumed dividend reinvestment combined with a few assumed splits over the life of the investment. I guess I just have trouble understanding the return compared to a savings account, for example. Is it assuming some compounding occuring on the company balance sheet?

Does any of my question make sense?

Thanks a ton, love the site.

(Edited for additional info/clarity)

Re: Compound interest on stocks

PostPosted: Fri Mar 07, 2008 10:56 am
by Alan
Yes, it compounds because of divident reinvestment.

GOOG doesn't pay dividends. Supposedly they are reinvesting your dividends for you.