How Compound Interest Works With ETFs


For more than 25 years, investors have been able to take advantage of the unique financial instruments known as exchange-traded funds. In essence, ETFs are equity securities listed on public financial exchanges such as the Nasdaq and the New York Stock Exchange, but they are not shares of companies; instead, they track the financial performance of various instruments that can range from stocks to benchmark indices and from bonds to commodities.

To a great extent, ETFs are similar to managed mutual funds such as the ones tied to many retirement plans such as 401(k), but you can purchase them like stocks on the open market. The Vanguard S&P 500 ETF, for example, is one of the most heavily traded securities on Wall Street, and it is tied to the performance of the 500 largest publicly-traded companies in terms of market capitalization. During the second week of December 2020, this ETF traded around $70; considering that its price at the time of its 2012 launch was $25, it would be safe to say that this is a good investment.

Appeals of ETFs for Compound Interest Investors

Here’s an interesting aspect of ETFs and why they should appeal to the compound interest investor: quite a few of them are managed under the principles of compounding, and this is a feature they inherited from mutual funds. The prospectus of an ETF will provide information about its compound interest functionality, but you do not have to figure it out because it is already reflected on the market price. ETF managers are into compounding for the same reason everyone else is, because they want to maximize profits on the assets they manage.

Compound interest investors can make the most out of their ETFs when they put capital gains to work for them.

Compound interest investors can make the most out of their ETFs when they put capital gains to work for them. When you feel that the ETFs in your portfolio have performed adequately and may go through a bearish period, you can sell them in order to rake in the profits, but instead of spending those proceeds or using them to buy other ETFs, you could deposit them into the passive instruments in your compounding portfolio; we are talking about high-yield savings and money market accounts that compound on a daily basis.