Compound interest is the eighth wonder of the world. He who understands it…earn it. He who doesn’t… pay it.” Albert Einstein.
As the above quote of great scientist explains the value of compounding itself. The general definition of compounding is earn on earnings means earn more on your interest also on long term investment. The technical definition of Compounding is the reinvestment of interest at the same rate of return which we are getting on principal amount, year on year. The value of the investment grows vertical in increasing way rather than horizontally.
Why choose compounding?
If a person want to grow his money in long term investment goal, must choose compounding formula. Compounding makes your money multiply in such a way that other investment formats could not give you the same result.
Once you choose your goal and time, you can easily achieve it if you invest the correct amount in some good investment option having compounding format.
What are the important factors for compounding?
- Start Investment: It is not necessary to start it early but if someone does it on right time can make a wealth. If anyone starts investing from the day he start working, can grow his money multi fold over the period of time. It provide the time for money to grow and make wealth for future goals. Start from any small amount that can be upto 5 to 10 percent of your monthly income.
- Discipline & Calm: Continue investment makes you a disciplined and patient human being and over the time these two habits convert your money a huge asset for you. Once you have the discipline of investing, you also start the habit of saving money and avoid the unnecessary expanses which you are doing presently. There are so many financial calculators available to choose to achieve your financial goal.
Let understand it with an example:
Kareena and Karishma both sisters who have just started their career at the age of 20 and plan to retire at age 65. Kareena starts saving Rs. 6,000 every year from age 20 and continues to do until she is 35 years old, after age 35 she is stops making any further investment. On other hand, Karishama starts saving Rs. 13,000 every year from the age of 35 and continues to do until she retires at the age of 65. if both earn, say, 9% per annum on their investment then both will wealthier when they will retire at the age of 65. Surprising, isn’t it? At 65, Kareena would have accumulated Rs. 28.37 lakh whereas Karishama wealth would have been lower at Rs. 21.03 lakh while Kareena total investment was Rs. 90,000 and of Karishama Rs. 3,90,000.
The result would be the same even if one considers a one-time investment. For example, assume that Kareena invests Rs. 10,000 at the age of 20 in an instrument that fetches 15% per annum. Karishama, on the other hand, invests Rs. 100,000 at the age of 40 in the same instrument. When both turns 60, Kareen’s Rs. 10,000 investment would have grown to Rs. 26.78 lakh, while Karishama’s Rs 1 lakh would have grown to only Rs. 16.37 lakh.
Thus, the longer you stay invested the more money you will make. The best way to take benefit of compounding is to start saving and investing wisely as early as possible. The earlier you start investing, the greater will be the power of compounding.
Above example clearly shows that how Ram has earn Rs.693.28 more than Shyam on the same amount invested for the same number of years, just because of compounding interest.