“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn’t … pays it.”
Albert Einstein
At first this quote might seem like a bit of an exaggeration but the math behind it shows that it is not.
The concept of compounding power involves the practice of ‘accumulating interest upon interest.’ This means that the money you invest will yield returns not only on the initial principal amount but also on the previously accumulated earnings from previous compounding periods.
Multiple investment vehicles, including fixed deposits and mutual funds, utilize a process of reinvesting your funds’ earnings, whether derived from interest or capital gains, with the goal of producing additional profits over time.
How Can You Improve Your Savings with Compounding Benefits?
Make an early start
The more time you keep your investments untouched, without making withdrawals from your returns, the more your money can grow, thanks to the exponential increase in the power of compounding over time.
| Investment Amount (in Lakhs) | Rate of Return p.a. | Age at which Investment is made | Age at which Investment is withdrawn | Compounding Period (Years) | Value of Investment (in Lakhs) |
|---|---|---|---|---|---|
| 5 | 10% | 45 Years | 60 Years | 15 | 21 |
| 5 | 10% | 40 Years | 60 Years | 20 | 34 |
| 5 | 10% | 35 Years | 60 Years | 25 | 54 |
| 5 | 10% | 30 Years | 60 Years | 30 | 87 |
Shorter tenors have greater compounding impact
Compounding frequency, the rate at which interest multiplies, varies among investment options. Choices include daily, monthly, quarterly, bi-annually, or annually. Shorter compounding intervals have a more pronounced effect on investment growth, highlighting another facet of the power of compounding.
| Investment Amount | Rate of Return p.a. | Compounded Frequency | Tenor | Compounding Periods | Value of Investment |
|---|---|---|---|---|---|
| 100000 | 12% | Annual | 5 Years | 5 | 176234 |
| 100000 | 12% | Half yearly | 5 Years | 10 | 179085 |
| 100000 | 12% | Quarterly | 5 Years | 20 | 180611 |
| 100000 | 12% | Monthly | 5 Years | 60 | 181670 |
Be disciplined and patient
Building a strong investment portfolio begins with setting clear priorities and maintaining discipline. Leveraging the power of compounding is essential for maximizing returns. Regardless of your income, take time to define your goals and preferences. This understanding is key to harnessing the advantages of consistent, long-term investments and the role of compounding.
Choose the right instruments or fund
While you might lack the expertise of an experienced stock investor, don’t assume that the power of compounding isn’t accessible to you. Although equities can be volatile, they historically offer strong inflation-adjusted returns over time. Consider using stop-loss strategies to limit potential losses in your investments.
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