Albert Einstein termed compound interest as the eighth wonder of the world. According to Einstein, compound interest is the most powerful force in the world. ‘He who understands it, earns it … he who doesn’t … pays it.’
So, what really is compound interest?
To understand the meaning and magic of compound interest on your investments, let’s take a simple example:
John invests INR 10,000 in the shares of a blue-chip company. In the first year of investment, his shares rise 10 percent, taking his investment to INR 11,000.
In the subsequent year, the shares rise by another 10%. Now, after the second year, the value of his investment stands at INR 12,100.
In this example, instead of simply earning an additional 1,000 rupees, like the first year, John’s investment grew by 1,100 rupees in the second year, because the 1,000 rupees he gained in the first year grew by 10 percent as well.
Of course, the above example uses very small numbers for the ease of understanding. Once you start using real figures, the numbers can get quite large. In fact, INR 10,000 invested at a rate of 10 percent per annum for 20 years yield INR 67,276 without adding a single rupee to it! Isn’t the power of compounding magical?
The concept behind compound interest is quite straightforward. Simply put, when you invest money, you earn interest on your principal. If the interest is paid annually, in the subsequent year, you would earn interest on the sum of your principal and the interest you earned in the first year. In the third year, interest would accumulate on principal and interest you earned in the past two years. This cycle would continue throughout the term, making your money work for you rapidly – as you continue to earn interest on your interest – without having to do anything actively.
Start early to reap more
Timing is everything! And that holds true when you talk about compounding as well. We have all heard that good things come in time, similarly, the more time you give compounding to work its magic, the ‘fatter’ would be the results.
Would you be surprised if we tell you that investing INR 1,000 each month when you are 20 would lead to a bigger corpus at retirement (say 50 years of age) than investing INR 2,000 each month from the age of 30?
Of course, the success of your financial portfolio also depends on the choices you make. Especially over long periods of time, even a difference of up to 1 percent in your rate can significantly affect your returns.
Thus, a savvy investor is a vigilant one. By understanding the market better and choosing the right investment products, small, regular savings can lead to big treasures in the future.
At TradeGyani, we help you get started and proceed on your financial journey with élan. Join the fast-growing community of investors who are making a killing by simply following the personal investment portfolios of licensed trade experts with proven track records.