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Why is the Power of Compounding important to investors?

Imagine making your money work for you in a way that gets you extra returns on your investments. Wouldn’t that be amazing?

This is what compounding is all about. 

Most investment avenues today offer the benefit of compounded returns. If you give time to your investments, you can unlock their compounding potential and get exponential returns.

Compounding is such an important principle that Albert Einstein is believed to have said, “Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.

But, do you know what exactly is compounding and how it works?

If you don’t, let’s learn everything about compounding.

The concept of compounding is not rocket science. It simply means earning returns on the returns that you have already earned. Confused? Don’t be. Here’s an example to simplify things.

Suppose you invest Rs.10,000 to receive an interest rate of 12% every year. In the first year, you will earn Rs. 1,200 in return.

Now, if you reinvest this return in the second year, you will earn a 12% return on a sum of Rs. 10,000 + 1,200, which gives you a larger return of Rs. 1,344 in the second year!

In this example, the return that you earn every year would be as follows:

Year 1: 10,000 * 12% = Rs.1,200
Year 2: (10,000 + 1,200) * 12% = Rs.1,344
Year 3: (10,000 + 1,200 + 1,344) * 12% = Rs.1,505

As you can see, every year, the interest you earned in previous years is added to the invested amount, which leads to higher compounded returns!

This is how compounding works. You get returns on the already earned returns. Simple, isn’t it?

If you invest for a long-term period, you can end up with a sizable chunk of money; all because of compounding!

Here’s another example of how compounding multiplies your returns.

Suppose you invest Rs. 5,000 every month for 15 years. Assume that the return rate is 12% compounded every 6 months.

15 years later, your investment will have multiplied to Rs.24.54 lakhs, even though you have invested only Rs.9 lakhs in total.

The rest, Rs.15.54 lakhs, is the compounded return!

Compounding is a simple concept which also forms the basis of investing.

Learn investing with MProfit as you start your investing journey. Understand the concept of compounding and see how it works wonders for your investing!

26 February, 2021

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