Compounding is considered by many to be one of the strongest forces in the financial world. Buffett even considers it to be the eighth wonder of the world. Understanding how to take advantage of compounding is essential for investing success.

At the most basic level, compounding occurs when an investment makes money, then that money contributes to making even more money. This snowballing effect of previous gains contributing to increases in future gains causes an exponentially increasing return on the initial investment. A key component is to not interrupt the continuously building cycle, as doing so may disrupt the self-feeding loop and have a major impact on the final results. The other key element is to let it work over the long term; while compounding is extremely powerful, it can also take time to play out.

Let’s take a simple example stock that grows 5% each year, and pays an annual dividend that also grows 5% each year. Your initial investment is $10,000 for 100 shares at $100, with a first dividend payment of $2 per share.

Now compare the compounding growth table above to the non-compounding growth table below. You’ll see that compounding provides an additional 9% return on the investment, or roughly $900 in this scenario, and results in a dividend payment roughly 20% greater due to the increase in shares accumulated.