Yes, you heard it right, compounding has the power to significantly change your financial situation over the years. Einstein considered the power of compounding as the eighth wonder of the world-

“compounding is the process in which an asset’s earnings are reinvested to generate more earnings.”

Imagine a rolling snowball down a hill, it started as a tiny snowball, as it rolls down it gains momentum and accumulates more and more snow. When it reaches on the bottom, it’s no longer that tiny little ball it has become a giant snowball.

In financial investment, compound Interest does the same job. Your small investment amount accumulates interest along with the principal and multiplies over the years.

Many successful people considered investing and revealed compounding as their secret to achieving great wealth, Billionaire Warren Buffet Says-

If the great minds like him keep preaching it then there must be something great about it.

so, now you’ve got enough idea why the topic deserves your attention.

*okay, Vatsala I got your point, but how can I take benefit of compounding?*

well, you will get your answer, but before that, it’s important to understand the concept practically.

## What is compound interest?

Compound Interest is the interest earned on the previously earned interest along with the principal amount.

Simple interest only earns you interest on your principal amount. Whereas Compounding allows you to earn interest on your principal plus previously accumulated interest, that got reinvested which was earned previously on the principal.

Let’s understand it with practical example-

Two friends invested ₹2,00,000 with interest rate 9% for 10 years, the only difference is-

Mr. A opt for an option where compound Interest is used &

Mr. B opt an option where Simple Interest is used.

Particulars | Mr. ‘A’ | Mr. ‘B’ |

Amount Invested | ₹ 2,00,000 | ₹ 2,00,000 |

Interest Rate | 9% | 9% |

Stayed Invested (years) | 10 | 10 |

Maturity Amount | ₹ 4,73,000 | ₹ 3,80,000 |

Profit Difference | ₹ 93,000 |

As you can see in the table, how in the same time period and with the same interest rate the difference in profit is significant. Mr. ‘A’ got the profit of 93,000, which is considerably higher than Mr B.

Let’s see it in a graph, (the example is the same, I’ve just increased the time to 30 yr so that you can get the clear picture)-

As you can see from the graph. In initial years, it looks similar but after a certain point, the difference increased significantly.

Simple interest has linear growth. Whereas compound interest grows exponentially. We can also see from its equation-

## A=P(1+r/n)^{nt}

where,

- A= Final Amount(principal + interest ),
- P= Principal Amount,
- r= Interest Rate,
- n= Number of times interest is compounded per year,
- t= Time(years)

## Key factors which make compounding even more powerful:

### Time:

Keep in mind that compounding is not a “get rich quick scheme”. It requires time, a lot of it. If you have a longer time horizon and you start early it can multiply your investments. let’s understand it by a chart-

Suppose a person invests ₹2,00,000 at @10 % compounding interest, we will see how the invested money grows exponentially over time

Time | Amount |

0 years | ₹ 2,00,000 |

5 years | ₹ 3,22,000 |

10 years | ₹ 5,19,000 |

20 years | ₹13,46,000 |

30 years | ₹ 34,90,000 |

you can see how time multiplies wealth when compounding is applied. The power of compounding increases exponentially with time.

### Frequency Of Compounding:

Most of the time people only focus on the rate of interest, but the frequency of compounding (The number of times the interest is calculated in a year ) also plays a major role for making good returns.

It could be monthly, quarterly, half-yearly. Like if the frequency is 2, the interest will be calculated two times per year.

The higher the frequency of compounding , the more return one can expect.

### Rate Of Interest:

The compound interest rate is also one of the biggest factors for getting a high return on your investment.

let’s take another example:

let’s say you have ₹10 lakh to invest, and you choose five different options and put ₹ 2 lakh in every option for 10 years.

let’s see the difference in returns after 10 year

Investment Options | Interest Rate | Amount after 10 yr |

Saving Account | 4% | 2.96 lakhs |

Bank F.D | 7% | 3.93 lakhs |

Debt funds | 8% | 4.32 lakhs |

Equity Funds | 12% | 6.21 lakhs |

Shares | 15% | 8.09 lakhs |

*Note: Interest rate may vary, I have taken average approximated value for calculations.*

There is a great tool by ICICI Prulife, you may calculate by yourself- click here.

so, you’ve seen in the table, with the same investment amount the power of compounding gets a rapid hike, the return after ten years is completely different in every option because the rate of interest is one of the biggest factors in compounding.

But that doesn’t mean you can invest blindly in the options having the highest rate of returns. Because the more return will be, the more risk would be associated with it. So a beginner should always go for a balanced option where risk and returns are balanced.

Okay, so what are that options ?

Don’t worry! I will be explaining every option separately in the upcoming articles along with its pros and cons so that you can pick one which suits you the best.

I hope you liked the article, and if you liked it then please do let me know in the comments because that keeps me motivated to create more such quality content for you!

## Apoorve Verma

27 May 2020Very interesting and informative waiting for the next part, Thank you. Keep growing!!

## Vatsala

28 May 2020thanks a lot, Apoorv.

The next part is coming soon. cheers!

## Akshay

28 May 2020The way you elaborate is fantastic.I think it’s better platform to quench the financial thirst . Well explanation. I would like to give 5 stars.. Thank you so much such a useful topic.

## Vatsala

28 May 2020glad you liked it, thank you so much for taking time to write to us!

## Amit Kashyap

28 May 2020Very informative, I was searching for something like this only. Thanks for sharing your knowledge.

## Vatsala

28 May 2020Thank you so much your kind words of appreciation, stay tuned!

## ปั๊มไลค์

29 May 2020Like!! Thank you for publishing this awesome article.

## Dipanjan Shukla

30 May 2020this is unique in simple language ….very good kerp it up