Grow Financially With Power of Compounding

Ever wondered about the secret behind the financial growth of popular investors? It is a mix of smart investment choices, experience, and compound interest. For a novice investor, compound interest might sound like fancy jargon, but you do not want to miss out on the beneficial impact of compounding.World-renowned physicist Albert Einstein called compound interest the 'Eighth Wonder of the world'. Intrigued enough? Let's understand this ‘8thwonder’ more deeply:

The power of compounding is using the impact of compounding on increasing your capital over the years. Compounding an investment means that once you invest capital, the return generated is added to the investment, and the new return is generated based on this new capital. This cycle continues and, with time, leaves a huge corpus in your hand.Often individuals tend to confuse simple interest with compound interest. However, they are two fundamentally distinct arithmetic properties. Simple interest involves calculating the returns on the individual capital only, while in compound interest, interest is calculated on the collective sum of capital and the previous interests. For example, you invest Rs 10,000 in two financial tools. Both offer a 10% return per annum. However, the first one generates returns based on simple interest, and the second one generates returns based on compound interest. After five years:

• Your first investment grows to Rs15,000
• Your second investment grows to Rs16,105

Investments, when compounded, offers much greater returns as compared to simple interest. Your investment can potentially grow exponentially, when compounded.

It has been well said that compounding is a fruit that gets sweeter over the years. Suppose that you invest Rs.25,000 in a fund that offers a return of 10% compounded yearly. The table below shows the money accumulated periodically over the years:

So after 25 years, your investment of Rs 25,000 grows by 11 times the initial investment. As apparent by the table above, your investment grew nearly Rs 15,000 in the first 5-year period. Compared to the last 5-year period, from year 20-25, your investment returned a whooping 1 lakh rupees.This shows that if you offer more time for your money to grow, it can provide you with more significant gains. The tremendous power of compounding shows a drastic result in the later years when the amount accumulated increases.

Just like any other investment, your chances of getting more return increases if you pitch in more capital. Let's re-analyse the previous example. There, you locked in Rs 25,000 for 25 years. So imagine what happens if you lock in a much larger amount, say Rs 5,00,000. Here the rate of interest is the same, that is 10% and is compounded yearly. Let's check the table now.

Here your investment again grows 11 times the capital invested. You earned a return of Rs 2,50,000 on your Rs 25,000 investment, while here you get a Rs 50,00,000 return on your 5-lakh investment. So, the impact of compounding remains the same on each capital, but it offers tremendous returns as you increase the capital investment.Investing in a large capital can help you build a significantly high corpus via the power of compounding . It is equally important to keep in mind the unwanted results of tying a large capital in one investment medium. This is why it is important to invest in different asset classes. However, don't forget to ensure that your returns are reinvested for better gains.

A lot of people tend to periodically withdraw the interest generated and use it as their regular income. These investors are possibly missing out on the terrific compounding effect and its impact on their financial health. The returns earned on your capital needs to be reinvested continually to generate substantial returns over the years. Then only compounding will work in your favour.

Compounding is an incredible tool that can have a huge impact on your financial growth. You must start investing early to enjoy a better gain on your capital. Financial experts advise you to research a fund thoroughly before you start investing.During the early years of investment, you might not see the drastic change as expected. But as the years go by, your capital will potentially exemplify to an amount that can support your most ambitious financial goals.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.