Power of Compounding

"Compound interest is the eighth wonder of the world. He who understands it, earns it ... he who doesn't ... pays it."

Albert Einstein

You have heard in numerous articles about terms like compound interest and ROI (return on investment). While some of you may already be aware of how compound interest works, this article shares the phenomenal power of compounding.

Here the interest is re added to the principal amount and then interest for next time period is calculated, hence the word compound. Here, the amount is calculated by the following formula:

\[A = {P} {( 1+{r\over n})}^{nt}\]

Where: A= Amount P= Principal r= Rate of interest n= Number of times interest is compounderd per year t= Time (in years)

Compound interest is used heavily in the finance sector. All loans work on compound interest. It is used to calculate the future cost of any commodity.

As we go further, we realize why compounding is so significant. The Sooner one starts to invest, the bigger the corpus generated. Late one starts, and a bigger investment is required to get the same corpus. Have a look at the table:

Assume you are investing Rs. 10,000 per month at an interest rate of 8% (while return on investment in equities delivers more than 10%, a conservative figure of 8% has been chosen for calculation) till you are 65. Starting at an age of 25 Yrs, you will make Rs. 3.35 Crores by the time you hit 65! Whereas, if you start 5 years late and invest the same amount, you will only make Rs. 2.23 Crores . 5 more years, and the figure will further drop to Rs. 1.46 Crores .

Therefore, it is absolutely essential to start investing as early as possible for maximum gains.

While compounding gives you maximum benefit, it also gives maximum time penalty. Assuming you started investment late, and you still want to attain the same corpus you desired when you were say 5 years younger, you have to invest a lot higher amount. Have a look at this table:

In the previous table, we saw that if you start investing Rs. 10,000 per month at 8% p.a. ROI, you will end up with a corpus of Rs. 3.35 Crores. If you start investing 5 years later, you will have to invest Rs. 15,000 per month to attain the same corpus. If you start 10 years late, you have to invest Rs. 22,900 ! Hence, you realize the later you start, the more you have to pay to reach your goal!

Therefore, it is of utmost urgency that you decide your goal, calculate your investment, and start today! Every day missed is added money to the monthly investment!