Compounding is a magnificent tool for wealth creation that’s been put to use by some of the wealthiest people around the world, for building their wealth by leveraging time and patience to their advantage. Compounding involves parking or investing your money in one instrument for an extended time span, and waiting patiently for it to grow, without withdrawing it.
When you invest a certain sum of money in a good investment instrument, it grows a little every year. After the first year itself, if you do not withdraw this sum of money in whole or part, it keeps accumulating, and every year you earn interest not only on the principle, but you also earn interest in the interest.
On the other hand, if you withdraw the interest every year, you only keep earning returns on the initial investment. Your money doesn’t really grow, nor does it get you any closer to achieving your financial goals.
The difference between simple interest and compound interest is pretty simple. To understand this better, take a look at the tables below.
|Number of Years||Accumulated Amount (₹)||Rate of Interest (%)||Simple Interest (₹)|
|Total in Year 10||10,000||12,500|
|Number of Years||Accumulated Amount (₹)||Rate of Interest (%)||Compound Interest (₹)|
|Total in Year 10||32,473||22,473|
As can be seen from the Simple Interest Table, the total interest accrued after 10 years is only ₹12,500.
On the other hand, if you look at the Compound Interest Table, the total interest accrued at the end of 10 years is ₹22,473, and the total amount accrued with Compound Interest is ₹ 32,473.
When you invest your money in Mutual Funds, unless you specifically opt for a Dividend Payout module, your earnings (interest from debt instruments and dividends from equity instruments) keep getting reinvested. This means, you don’t just earn interest on the principal amount, but you also earn interest on the interest.
Instead of growing arithmetically, your money starts to grow geometrically when you invest it in a good mutual fund. Another important point to remember when it comes to compounding is, the longer you stay invested, the more your money compounds. For the first few years, compounding does not show any extravagant results.
But, if you wait long enough, you could start out real small and make it very big. This makes it very beneficial to start investing early in life. Many people who started investing smartly in their early twenties have managed to buy their own home and retire comfortably by the time they hit forty-five.
To start gaining through the Power of Compounding, Download the Tarrakki App for Wealth Management and Make your First Investment.