The Power Of Compounding & How It Works

Compounding is the single greatest thing to have ever happened in terms of personal finance. But barring a few, not many of us completely understand how magically it increases the net worth of our money if kept invested for long. Let us first understand what compounding is and how it affects every one of us.

To begin with, compounding is nothing new to most of us. We all had been introduced to this concept during our schooling in the form of compound interest Compounding is the process of exponential growth. Suppose you invest Rs. 1 lakh in instruments that earn a compounded return, say 1% per month, for the 1st month you earn interest on Rs. 1 lakh, but for next month the interest is on your principal plus the interest earned in the 1st month. That means, not only your initial investment is giving you return, but you are getting return on your return. And for every subsequent month, this will keep on multiplying. Simply put, you are benefited in two ways, firstly your investment is giving your return and secondly, by virtue of that return, your investment itself is growing.

Let us observe this with a simple example. We all know the power of doubling. That is, if we start putting Rs. 1 today and keep on doubling the amount, at the end of the month(considering the month to be 30 days), the deposit on 30th day will be Rs. 53,68,70,912. Huh! That’s a big number. But practically speaking, nothing grows at this rate even yearly. So, let us take a practical example.

Suppose you start investing at the age of 25 years, investing a mere Rs. 2500/- per month. Now, you plan to retire at the age of 60. Supposing that you keep on investing until you reach the age of 60, the amount of investment that you will end up making at the time of your retirement will be

35(years)*(12 months)*2500(per month) = Rs. 10,50,000.

That means you invested Rs. 10,50,000 over a period of 35 years which is not a very big amount. Now, assume that you invested in instruments that give on an average 12% per year return on your investment that is compounded annually, the amount you will receive at the end of 35 years will be Rs. 1,37,77,077. That means whereas the amount you invested was only Rs. 10,50,000, the value of your invest has gone up to Rs. 1,37,77,077, thanks to the power of compounding. Wow! that’s tremendous. Now assume that you don’t touch this amount and reinvest it in any other financial instrument that give you flat 12% return, that is simple interest of 1% per month, so that you take care of your necessities after your retirement by way of interest income. Still, you earn Rs. 1,37,771 per month. That means by just investing Rs. 2500/- per month, the amount of benefit you receive is Rs. 1,37,771 per month on your retirement for your entire life which is around 55 times of what you invested per month, that too without touching the actual amount that you received at the time of your retirement.

Now imagine the return you obtain if you keep growing your investment with time as your income increases. The result will be tremendous. Yes, that’s the magic of compounding! If properly invested, it does not only take care of your retirement, but it can make you rich. So dear readers, let’s celebrate the power of compounding and start investing and start the process of growth and becoming rich. Remember the early you invest, the more will be the time you allow for the compounding to unleash its power. Make your money work for you to take care of you. Use the power of exponential growth. Cheers!

Use the following calculator to calculate how your monthly investment grows after certain period of time: