Compounding is a powerful tool that helps investors accumulate wealth over time. It is the process of earning interest on both the principal amount and the interest earned on that principal amount. This means that over time, the growth of an investment can increase exponentially. The power of compounding can be illustrated using the rupee symbol.
Imagine that you invest Rs. 1,00,000 in a fixed deposit account that offers an annual interest rate of 8%. After one year, your investment would grow to Rs. 1,08,000. However, if you reinvest that Rs. 8,000 interest back into the fixed deposit account, your new principal amount for the second year would be Rs. 1,08,000 instead of Rs. 1,00,000. This means that after the second year, your investment would grow to Rs. 1,16,640, instead of Rs. 1,16,000 if you had not reinvested the interest earned.
As you can see, the power of compounding is clear in this example. Over time, your investment will grow at an increasing rate, and the longer you let it compound, the more significant the difference in returns will be. This is why it is essential to start investing early and let your money compound over the long term.
To further illustrate the power of compounding, let’s look at a hypothetical scenario where two individuals, A and B, start investing at the age of 25. Assume that both A and B invest Rs. 5,000 every month, and they both earn an annual return of 10%. However, A stops investing after 10 years, while B continues to invest for 30 years.
After 10 years, A would have invested a total of Rs. 6,00,000, and assuming an annual return of 10%, the value of the investment would be Rs. 11,74,819. On the other hand, B would have invested a total of Rs. 18,00,000 over 30 years, and the value of the investment would be Rs. 1,50,94,239.
This shows that even though B invested three times more than A, the power of compounding allowed B’s investment to grow exponentially over the long term. This is why it is essential to start investing early and let your investments compound over time.
Another example of the power of compounding can be seen in the case of a person who starts saving and investing for retirement at the age of 30. Assume that this person invests Rs. 10,000 every month in a mutual fund that offers an average annual return of 12% and continues to do so until the age of 60.
After 30 years, the total investment would be Rs. 36,00,000, and the value of the investment would be Rs. 5,03,35,682. This means that the person would have earned a return of Rs. 4,67,35,682 over 30 years, which is almost 13 times the amount invested.
These examples show that the power of compounding is a potent tool for wealth creation. It is not just limited to investments in stocks or mutual funds but can also be applied to other financial instruments like fixed deposits, recurring deposits, and even savings accounts.
It is important to note that while the power of compounding can help investors accumulate significant wealth over time, it is not a guarantee of high returns. It is crucial to invest in a diversified portfolio of assets and make informed investment decisions based on one’s financial goals, risk appetite, and investment horizon.
In conclusion, the power of compounding is a powerful tool that can help investors accumulate wealth over time.
