Power of Compounding

 Benefits of compounding & reasons to start early

“Most great fortunes are built slowly. They are based on the principle of compound interest, what Albert Einstein called, ‘the greatest power in the universe’.”
- Brian Tracy (American-Canadian motivational speaker)

“Compound interest is the eighth wonder of the world. He who understands it, earns it; and he who doesn’t, pays it.” Give us some moment so that you can earn it.

When we say simple interest, it means, you are receiving interest on the original principal amount. Hence, you receive the same interest rate throughout the investment period. This is much more evident in sovereign gold bonds (SGB) as here; you receive a simple interest of 2.5 per cent. On the contrary, in the case of compound interest, you not just receive interest on your initial investment but also, on the previously accumulated interest. This means you are receiving interest on your principal as well as on your interest.

Let us understand this with the help of an example. Say, for instance, there are two friends Rohit and Amit. Both invested Rs 5,000 every month for 10 years. However, Rohit invested in security that provided simple interest and Amit invested in security that provided him the compound interest. Both received interest of 8 per cent per annum. Now, let us look at the amount that both must have accumulated in the span of 10 years.

Indeed, compound interest wins as against simple interest. Having said that, the early you start investing, the better it is. This is because to see a noticeable benefit of compounding, your investment horizon needs to be long-term.

Starting early helps you to reap the benefits of compound interest. To understand this, let us take another example. Rohit and Amit started investing in mutual funds.

However, Rohit started his investment at the age of 25 and Amit started late, at the age of 30. When both of them turned 50, they had invested a total of Rs 12.5 lakh each i.e. Rohit had invested Rs 50,000 per annum, while Amit invested Rs 62,500 per annum. The info-graphics below will help you to understand the importance of compounding as well as starting early.

Benefits of compounding & starting early:

• Starting early gives you the benefit of investing smaller amounts.
• Staying invested for a longer period of time helps you to reap compounding benefits and get better risk-adjusted returns.
• Compounding helps you to achieve your financial goals.

Conclusion: 

In order to achieve financial goals one must follow the principles of Compounding in his/her early stages of life. Compounding is like the nitro boost to your engine which helps you generate alpha returns over a period of time, Hence a must recommended strategy for every individual.