Compound interest is popularly known as the eighth wonder of the world. While the concept was introduced to us in school, it is only when we start managing our investments that we realise the potential it holds for wealth generation.
 

In simple terms, compound interest is when the interest earned on an investment is reinvested to earn interest on interest. While this might sound a little complicated, in this article, we will demystify compound interest to help you leverage its power to boost your savings.
 

Understanding the Power of Compounding
 

To explain the power of compounding, let’s look at a simple example.
 

You invest ₹1 Lakh every year in an instrument that offers a compound interest rate of 6% with interest compounded annually. You invest this amount for 20 years. So, at the end of 20 years, you have invested a total of ₹20 Lakh at an interest rate of 6% per annum.
 

Let’s take 2 scenarios:
 

Scenario1:
 

You invest ₹1 Lakh every year, reinvest the principal but withdraw the interest at the end of the year.
 

Therefore, at the end of the first year, you will reinvest ₹1 Lakh, withdraw ₹6000, and invest ₹1 Lakh more. Hence, for the second year, your invested amount would be ₹2 Lakh and the interest earned will be ₹12,000. Here is a table:
 

Hence, by the end of the 20th year, you would have invested ₹20 Lakh as principal and received a total interest of ₹12.6 Lakh.
 

Scenario 2:
 

You invest ₹1 Lakh every year and reinvest the principal and interest at the end of the year.
 

Therefore, at the end of the first year, you will reinvest ₹106000 and invest ₹1 Lakh more. Hence, for the second year, your invested amount would be ₹206,000, and the interest earned will be ₹12,360. Here is a table:
 

Hence, by the end of the 20th year, you would have invested ₹20 Lakh as principal and received a total interest of ₹18.99 Lakh.
 

This example highlights the compound interest benefits and how it works. As you can see, by using compound interest, you can earn more returns on the same investment at the same rate of interest.
 

Tips to Boost Your Savings Using the Power of Compounding
 

Here are some handy tips to boost your savings using compound interest schemes:
 

• Start early – Compound interest starts displaying its magic over the long term. Hence, if you start at a younger age, then by the time you cross 40 years of age, compound interest will start offering morereturns on your investments.
  
  
• Look for shorter compounding intervals – In the example above, we have described the power of compounding where the compounding interval was one year. If the compounding interval was shorter, then the interest earned would have been more.
  
  
• Be persistent – As mentioned above, you need to give your investment enough time to accumulate more returns through compounding. Hence, you need to be patient and persistent. Pre-mature withdrawals can reset the compounding tool, and you will not be able to earn the returns shown above.
  
  
• Choose investment instruments carefully – There are many investment options in India. If you want to use the power of compounding, then you can use any instrument that offers annual returns and keep reinvesting the earnings for as long as possible. However, make sure that you keep risks in mind while opting for market-linked instruments.
   

Always Have a Financial Security Net
 

While compound interest can help you create wealth efficiently over time, life is unpredictable, and hence, it is important to be prepared to manage any unforeseen disaster. This is where insurance comes in. Make sure that you and your family have health insurance.
 

Conclusion
 

As you can see, compound interest holds power to transform your savings into a sizeable corpus over time. Make sure that you choose your investments carefully and plan for the long term to leverage the power of compounding.


L&C/Advt/2022/Nov/2793