What is your ideal investment to become rich?
- A one-time investment that grows exponentially every year
- High returns that are safe and not impacted by market volatility
- Assured returns without the risk of capital loss
- An investment that does not need constant monitoring.
Luckily for you, investments that leverage the power of compounding tick all these boxes.
What does power of compounding mean?
The power of compounding refers to the power of compound interest. Compound interest is calculated on the initial investment amount as well as the cumulative interest earned from prior periods.
Simply put, power of compound interest is earning interest on interest, and this continues for the entire investment tenure.
How can you maximise the power of compounding?
Power of compounding depends upon two main factors:
Whoever said, “Time is Money”, was obviously referring to a compounding investment. For the power of compound interest to give you significant returns, it requires time and hence, more importantly, your patience.
The power of compounding is most effective as a long-term investment strategy. It makes your money earn more for you by continuously reinvesting the interest or dividends earned on your principal amount. In this way, it converts your money into a wealth-generating resource.
2) Rate of interest:
Choose a compounding investment that offers a higher rate of interest as even a slight variation can make a big difference to the cumulative returns at the end of the investment period.
An example will help you understand how it works.
The power of compounding uses this formula to calculate compound interest:
A = P (1+r/n) ^nt
o A = Maturity amount of the investment
o P = Principal amount invested
o r = Rate of interest
o n = Number of times interest is compounded per year
o t = Term or duration of the investment
The following power of compounding example will help you understand its benefits better.
Dhruv and Amisha both invest Rs. 5,00,000 in a fixed deposit that gives them a return of 10% per annum, for 5 years.
Dhruv is not interested in long-term saving and wants to spend money on frivolous things. He chooses a scheme that credits the interest to his bank account. Amisha, on the other hand, is saving up for her wedding, so she chooses an investment with compounding interest.
At the end of the investment tenure, Dhruv receives only the principal amount of Rs.5,00,000 as he has spent the Rs. 2,50,000 interest received over 5 years.
Amisha, on the other hand, earns a compounded interest of Rs. 3,05,255.00 in addition to her initial deposit of Rs. 5,00,000, so the total amount after 5 years is Rs. 8,05,255.00.
Compounding simplified with a power of compounding calculator.
The power of compounding calculator shows you how a small investment can grow considerably in the long term. All you do is enter a few details and the power of compounding calculator calculates compound interest online using the compound interest formula mentioned above.
A power of compounding calculator eases your investment stress as it gives you a much clear picture of what investments you need to make and for what duration, to fulfil your financial goals. You can also use it to evaluate multiple investment scenarios for wiser decision making as the results are transparent and infallible.
The earlier the better
Like most investments, the power of compounding needs time to work its magic. Here are three things you will have to do to make your money work hard for you.
1) Start early: Compounding investments need time to grow. The earlier you begin your investment journey, the more returns you get.
2) Stay focussed on your financial goals: Life will throw many temptations. Resist the temptation to make withdrawals as even a small change can impact potential returns.
3) Manage your expenses: Budget your monthly spends prudently to avoid the temptation of dipping into your investment. On the contrary, spare cash can be added to the fund to boost returns.
Power of compounding is an ideal investment strategy for wealth creation, provided you give the investment its due time. The earlier you start investing, the better the returns it will generate. Be patient, avoid the temptation to withdraw from the fund at any cost, and you will have an investment that bowls you over with its returns.
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