The power of compounding is a way to multiply your returns on investments and savings and thereby help you to meet your long-term goals. This concept can also be related to the “snowball effect” where a small snowball keeps on growing bigger as and when it rolls down the slope.
The power of compounding helps in multiplying the accumulated interest by adding returns to the previously earned interest. Thus, the power of compounding leads to exponential growth of the invested capital.
So, What is Power of Compounding?
Power of compounding or you can term it as “Adding interest on interest”. The power of compounding helps to grow your wealth by generating earnings from the principal amount and the interest earned previously.
How Does This Work?
Different investments such as fixed deposits and mutual funds work on the basis of the Power of Compounding. For instance, an investor invests Rs. 1 lakh per year for every 5 years, at the end of 5 years the amount stands to be 5 lakhs 80 thousand if the interest earned is 5%. In case if the rate of return increases to 8% the amount will grow up to 6.34 lakhs. The Power Of Compounding Calculator also helps to know the returns on the investment.
How Can The Power Of Compounding Help In Improving Your Savings?
Start Investing Early:
To enjoy the power of compounding, one should start investing early in life. The savings get a significant time to grow as power of compounding increases exponentially over time. The longer you stay invested without making any withdrawals the larger your corpus grows due to the power of compounding.
Choose Shorter Intervals Of Compounding:
The power of compounding also multiplies depending upon the frequency whether annually, quarterly or monthly. If the interval of compounding is on a shorter interval the benefit of earning more returns is also high.
For instance, an investor chooses to invest Rs. 10,000 in two investment scheme both offering 7% interest. The first investment allows interest that is compounded annually while the other investment allows interest compounded quarterly. After the end of 3 years, it is seen that in the first investment the investor earns Rs. 12,250 and in the second investment the investor earns Rs. 12,314. So, it is seen that the shorter interval of compounding shows higher returns as compared to the extended intervals.
If you have chosen for long-term investment scheme, it is best to invest in equities to encourage higher returns in the future. One can also use the power of compounding calculator to understand the returns that one can expect from an investment in a particular fund.
Be Disciplined And Patient In Investment:
To create a significant corpus, one needs to plan about the financial goals and preferences in life. Limiting the expenses and maximising investments for a longer duration would help leverage the power of compounding on the investments. This would also inculcate the habit of disciplined investment and also develop the patience to allow the capital to grow in the long term.
Choosing The Right Investment Option:
You may not be a seasoned financial investor but investing in any equity assets can deliver better returns in the long term. Also, one can choose to invest through a financial advisor to reap the benefits of compounding from investments.