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It refers to the ability of an investment to generate earnings not only on the principal amount but also on the accumulated interest over time. As a result, the power of compounding can turn a small investment into a significant amount of wealth in the long term.
Compounding can work for any investment type but it requires time and patience to achieve its full potential. The longer your money is invested, the more time it has to compound, and the greater the growth potential.
One of the main advantages of compound interest is that it allows you to earn a return on your investment over a period of time. You simply need to invest your money, regularly monitor and review your portfolio, and let it grow. This makes it an ideal strategy for long-term investors.
Another advantage of compounding is that it can lessen the impact of inflation. Over time, the purchasing power of money decreases as the prices of goods and services increase. Compounding can maintain the value of your money and protect it from the erosive effects of inflation.
To take advantage of the power of compounding, it's best to start investing early and to be consistent in your strategy.
| Year | Opening balance | Yearly interest of 6.5%* | Closing balance |
|---|---|---|---|
| 1 | INR1,000.00 | INR65.00 | INR1,065.00 |
| 2 | INR1,065.00 | INR69.22 | INR1,134.22 |
| 3 | INR1,134.22 | INR73.72 | INR1,207.94 |
| 4 | INR1,207.94 | INR78.52 | INR1,286.46 |
| 5 | INR1,286.46 | INR83.62 | INR1,370.08 |
| 10 | INR1,813.70 | INR117.89 | INR1,931.59 |
| Year | 1 | 1 |
|---|---|---|
| Opening balance | INR1,000.00 | INR1,000.00 |
| Yearly interest of 6.5%* | INR65.00 | INR65.00 |
| Closing balance | INR1,065.00 | INR1,065.00 |
| Year | 2 | 2 |
| Opening balance | INR1,065.00 | INR1,065.00 |
| Yearly interest of 6.5%* | INR69.22 | INR69.22 |
| Closing balance | INR1,134.22 | INR1,134.22 |
| Year | 3 | 3 |
| Opening balance | INR1,134.22 | INR1,134.22 |
| Yearly interest of 6.5%* | INR73.72 | INR73.72 |
| Closing balance | INR1,207.94 | INR1,207.94 |
| Year | 4 | 4 |
| Opening balance | INR1,207.94 | INR1,207.94 |
| Yearly interest of 6.5%* | INR78.52 | INR78.52 |
| Closing balance | INR1,286.46 | INR1,286.46 |
| Year | 5 | 5 |
| Opening balance | INR1,286.46 | INR1,286.46 |
| Yearly interest of 6.5%* | INR83.62 | INR83.62 |
| Closing balance | INR1,370.08 | INR1,370.08 |
| Year | 10 | 10 |
| Opening balance | INR1,813.70 | INR1,813.70 |
| Yearly interest of 6.5%* | INR117.89 | INR117.89 |
| Closing balance | INR1,931.59 | INR1,931.59 |
*The returns mentioned in the table are just for illustration and no assurance of future returns.
For example, if you were to put INR1,000 in your savings account at an annual interest rate of 6.5%, you’d earn INR65 of interest in the first full year. But in the second year, the amount you’d earn would increase – even if the annual interest rate stayed the same – because compound interest starts to kick in.
This might not seem like much of a difference, but the impact of compound interest increases over time. This impact is even greater when starting with a larger amount.
Here are some ways in which compound interest can grow your money.
The longer your money stays invested and earns returns, the more significant the compounding effect becomes. By investing a small amount regularly, what you earn is reinvested through compounding and your investment will grow over time.
Inflation erodes the purchasing power of money over time so it’s important to invest in assets that generate returns higher than the inflation rate. This means you can safeguard your wealth.
Compounding can help you achieve your long-term financial goals, such as saving for retirement or buying a house. By starting as soon as you can and investing consistently, you can take advantage of the compounding effect and grow your money.
The compounding effect can also boost the value of assets. By reinvesting the earnings generated by these assets, you can increase your wealth over time.
The power of compounding can gradually turn a small investment into a significant amount of wealth as the interest and returns you earn are reinvested. The longer your money stays invested and earns returns, the more significant the compounding effect becomes.
Compounding works best over a long period, requiring patience and consistency. It's not a get-rich-quick scheme but rather a strategy for gradual wealth creation.
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Be cautious against the allure of high returns in a short amount of time, as this can lead to trouble. Investments or opportunities promising unrealistically high returns can be indicators of investment scams, get-rich-quick schemes, or other fraudulent activities. It's essential for individuals to thoroughly research and understand the risk, and be wary of any offers that sound too good to be true.
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