# How does s&p500 compound work?

hi all
i dont have any investment in funds so i’m not sure how it works but I keep reading that an index like sp500 gives about 6-8% return yearly, and compounding will grow your capital even more.

Does this mean that at the end of each year you will have the balance adjusted automatically according to that year’s performance? I mean, if I enter at let say 3500pts and hold for 5 years, during which is had extremes highs, but then on the 5th year it goes back down to 3000pts and I exit, would I still have made profit or will it be like a perfect break even since 3000-3000 = 0 increase? cause if the balance will breakeven wouldn’t it means that there’s no compounding at all?

Are you using CFDs or Investing?

none yet as i’m still beginner and have demo’d forex so far, but i was looking into investing and i came across all of this.

No matter how i reason it out I can’t seem to uderstand how compounding is included in the equation

Ok…

So like you I had also just read up on your hypothetical scenario and have formed my own conclusion:

So the S&P 500 is sitting at 3,943.34 points right now, if you invested in it you can be confident that it will continue to go up but remember you can’t be 100% sure every year will go up. It is possible to make rough calculations to figure out the value in the next (t) years if you also know what interest you will be payed an how often.

Like you said:

So you can also figure that out that out with something called Compound Annual Growth Rate (CAGR) - This is assuming that the profits were reinvested at the end of each year of the investment’s lifespan.

This is the first time I have looked into this topic as well so I hope what I have given you at least gives you some idea.

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This is the first time I have looked into this topic as well so I hope what I have given you at least gives you some idea.

I’m not that good with math formulas so i’ll have to google more about it, but what i’m not quite understanding is this

This is assuming that the profits were reinvested at the end of each year of the investment’s lifespan.

how can one re-invest the profits if the trade/investment is still open? if you do not close the trade, it will remain as unrealized profit so there will be no compounding effect on it as there was no additional capital re-invested.

Hope you can understand this if not let me know

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Hi Lee-Gi,
I will try to explain this without complicated maths. If the market started at 3,000 and went to 4,000, it would be a 33% increase (the increase of 1,000 divided by what it was at the start 3,000 is 1/3 or 33%) If the second year it went up to 5,000, that is a 25% increase (increase of 1,000 / 4,000 = 25%). If the third year it went up to 6,000, that is a 20% increase (increase of 1,000 / 5,000 = 20%. Now in the fourth year, it goes down to 3,000. That is a loss, not a profit. And it is a 50% loss (-3,000 / 6,000 = -50%).

So if you had held the SP500 for four years and sold it at the end of four years, you would break even. But during the meantime, it had made +33%, +35%, +20% then -50% to get to that break even.

I hope this explains that there is compounding, but if the profit is negative (a loss) it still compounds with the positives, and in this example, the end result is no profit and no loss (break even)

But you didn’t take into consideration the fact that you will be payed interest on the profits - even if the S&P dropped back to breakeven there is still a small amount (or large) of capital left over so I think there is still profit to be had.

Thank you for the straightforward answer it is clearer than mine.

Hi Kian,
If you invest in shares that make up the S&P listing, you will receive dividends. I am not aware that an investment (or trading position) on the S&P index comes with “interest on the profits”. Another member may wish to comment on this. I have no direct experience in either investing or trading in S&P index or any other market index.

@Mondeoman
thanks a lot for your time to explain
but if you sum up the % you have 33+35+20-50 = 38% profit
so if you break even there’s no compounding in it no? or am i missing something?
so what happens to the +38% difference?