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When you make an investment, it is mainly with the aim to grow your wealth at a steady rate over a fixed number of years which is your investment horizon. In the same way, people also save some money in banks and fixed deposits for a predefined number of years to earn interest on their savings.
But over a period of time, saving a certain amount of money in a savings bank account and investing the same amount will not give you the same returns. This is because your money in a savings account will earn simple interest, where you earn a fixed interest only on the principal amount. As compared to simple interest, compound interest is when you earn interest on the interest of your principal investment amount on an annual basis.
Hence, each year, you earn higher interest on the interest of your principal amount. This is known as the power of compounding, where each year you have a new principal amount.
Read on to learn more about how compound interest works.
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Unit Linked Individual Life Insurance Savings Plan (UIN:110L112V04)
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When your earnings are reinvested at the same rate of return each year to increase your principal amount, it is known as compounding. This simply means that the money you have invested is earning interest and is showing steady growth instead of lying dormant during the investment tenure. Therefore, if the earnings are reinvested each year at the same interest rate, the year-on-year growth of the principal amount will be continual.
Consider how much one’s investment can grow if the principal amount comprises the collective interest from the previous years in which you calculate compound interest. Investors make use of compound interest to invest and grow their wealth over a long investment horizon. This makes it easier for them to plan their goals as well. When the investments are made for a longer investment period, the returns tend to be higher. With an early start, an investor can make the most out of a higher compound interest, which makes it easier to build their wealth. Over a period of time, the earnings are enhanced, increasing the investment corpus.
Compound interest can be calculated by:
Compounding applies to investments, loans and deposits and frequency compounding plays an important role here. Hence, if the frequency of compounding is higher, the compound interest will also be greater. Depending on the investment you may have selected, you can benefit from the frequency of compounding. For instance, credit card loans are compounded monthly, while savings in a bank account are compounded on a daily basis.
Most investors make it a point to invest small sums of funds regularly for a long investment horizon to get the most out of compound interest. For example, suppose you invest a principal amount of ₹100 and consider the compound interest rate as 5% per annum; the interest earned by the end of the year is ₹5, which is 5% of ₹100. If you reinvest this amount instead of withdrawing it, you earn another 5% on the interest of the new principal amount, which is ₹105. Hence, your new interest earned on this amount will be ₹5.25.
The compound interest (CI) calculator is an easy-to-use, free and quick tool that helps you calculate the expected returns on your investment. When you use this online tool, be sure to mention the following details:
With the help of the CI formula, you can know how your investment grows through compound interest.
CI = P (1+[r/n]) ^ nt – P
Where
P = principal amount
R = Annual nominal interest rate as a percent
r = R/100
n = Number of compounding periods per unit of time
T = Time in years
You can change the interest rates and the principal amount on the calculator as per your liking to see how compound interest works differently on different investment amounts and see the result as the amount you will receive on maturity.
Let us look at an example here.
Suppose you invest ₹50,000 with an annual interest rate of 10% for 5 years, you will earn an interest of ₹50,000*10% = ₹5,000 for the 1st year.
For the 2nd year, interest will be calculated on the new principal amount of ₹50,000 + ₹5,000 = ₹55,000.
So, interest earned will be ₹55,000*10% = ₹5,500 making the total amount as ₹60,500.
By the 5th year, your total amount would become ₹80,526 with an interest amount of ₹30,526.
There are some important benefits that you can make the most out of when using a compound interest calculator. This free online tool is open to everyone for use and is especially popular among investors because of its results. The benefits of using this calculator are:
Though the actual results of your investment will be different, a compound interest calculator is reliable enough to give you a close estimate of how much you need to invest and for how long the investment should go on.
You can change the values and switch up the investment amounts and tenures to make different investment roadmaps. By doing this, you realise which investment horizon will help your investments grow most suitably.
As mentioned, do not expect accurate results as the actual rate of interest and other factors such as inflation will vary periodically. However, by using this tool for your financial planning, you can get a fair estimate of how to invest.
The compound interest calculator is a free online tool that can be easily accessed on the official Tata AIA Life Insurance website. All this calculator needs is a few details, and in less than a minute, you will be able to calculate compound interest and how the power of compounding works on your investments.
Given below are some of the specifics that need to be mentioned in our power of compounding calculator.
This is the total amount of money that you want to invest. You can choose any amount here and decide the frequency of the investment. For instance, you may want to invest Rs 1000 each month.
Next, you get to choose how many years you would like to continue this investment. This enables you to decide the number of years during which you can invest your money and allow it to grow.
Pick an assumed or estimated rate of interest that can help you understand at what rate your investment will grow. It is not necessary that the rate of interest is the same as the one you select, but it should be a realistic figure.
After filling in these details, click on Calculate at the bottom of the calculator and on the next page, you will be able to see the total expected corpus you can generate in the given investment period, with the specified funds and estimated rate of interest.
Suppose you want to invest ₹10,000 on a yearly basis for 5 years, with the assumed rate of interest at 7% and want to continue with the investment for 10 years, then fill in these details on the online calculator and click on Calculate. You will then be able to see the total corpus generated on your investment which is nothing but the estimated returns on your investment.
When you invest a certain amount and earn interest on the interest of the investment, it is known as compounding. Simply put, the profits earned from your investment are reinvested in the same investment. Hence, compounding enables you to earn interest on the main investment and also on the interest earned on that investment.
This is how the power of compounding can aid in the growth of your investment returns over the investment horizon, especially if it is long-term. Therefore, it is essential that the investment you make should be frequent and steady so that your savings and investments can grow over a given time period. This ensures you can achieve your financial goals with less effort while making your money work harder.
Calculating compound interest can appear to be a cumbersome process for many investors since many of them are not well-versed with the complexities of mathematics. However, calculating compound interest has been simplified using a compound interest calculator. You can head to the Tata AIA Life Insurance official website to use our Compound Interest Calculator and compute the expected returns on your investment.
Investing and saving is a habit that requires a certain level of discipline. To ensure that you are able to channel your investments systematically and have the power of compounding to grow your investment, here are some key rules to follow:
Start Early
Start Early
Make Disciplined Investments
Make Disciplined Investments
Be Patient
Be Patient
Watch Your Spending
Watch Your Spending
Consider Interest Rates
Consider Interest Rates
Compounding Intervals
Compounding Intervals
Compounding is useful as investors can earn interest on the interest of their investment. Here are some benefits of compound interest
When you have to choose between compound interest and simple interest, it is not difficult to see why compound interest has the upper hand. The compounding frequency means the number of times the interest has been calculated on the investment during a given year.
When the number of compound interest increases, it means that there is an increase in the frequency of the compounding interest. Hence, be sure to look at how often interest is compounded when choosing an investment option.
When it comes to daily compounding, the interest will be compounded daily. Similarly, if your select an investment where the interest is compounded on a monthly basis, it indicates monthly compounding. In simple terms, depending on the compounding frequency, you will earn a fresh sum on your investment per the frequency.
However, it is important that you give your money enough time to grow. For this, it is advisable to start investing as early as you can, even if the investment amount is small.
Our experts are happy to help you!
What is the meaning of the power of compounding?
Power of compounding is the terminology used to explain the interest earned by the interest of your investment. In the case of simple interest, the principal amount does not change, and you can withdraw the interest. However, in compound interest, the principal amount increases each year since the interest on the initial principal amount is added up to get a new principal amount. And this keeps happening each year.
What is the difference between savings and investments?
Savings are often associated with banks and other low-risk instruments where your money is saved, and each year or through the policy term, the savings grow in accordance with a predetermined fixed rate of interest. However, in the case of investments, the investment instruments may carry a slightly higher amount of risk, even though there are low-risk market-linked instruments.
While traditional savings only fills the gap between income and expenditure, investments are aimed at helping you create long-term wealth.
Does the power of compounding only apply to investments?
No, the power of compounding also applies to savings; however, it is a term more closely associated with investments such as mutual funds or savings plans that are much more dynamic as compared to traditional savings.
Does compound interest help create wealth?
Since compound interest helps your money grow over the long term through the power of compounding, it can be useful for investors who are seeking to create and grow their wealth over the long term.
Why is compound interest better than simple interest?
In compound interest, the money grows each year as the interest on the principal amount is added to the principal amount to create a new principal amount. But for simple interest, the only interest that one can benefit from is the interest earned on the principal amount over a specified number of years. Here, the interest on the principal amount is not added to the principal amount for a boosted principal amount.
What is the frequency with which interest is compounded?
If you need to understand the power of compounding, you should be able to first understand the frequency of compound interest. Depending on the type of scheme or investment you have opted for, compound interest can work on your investments on a yearly, half-yearly, quarterly, monthly, and even daily basis
Is it possible to calculate compound interest?
You can calculate compound interest with the Tata AIA Compound Interest Calculator. All you need to do is fill in some necessary investment details such as the amount, investment horizon and the estimated rate of return to get the result.
Is the compound interest calculator free of cost and easy to use?
Yes, the compound interest calculator is a free online tool that takes under a few minutes to calculate the compound interest once you fill in the correct details.
What are some of the compound interest investments in India?
Here are some compound interest investments in India:
Is compound interest more effective on a daily basis or a monthly basis?
Daily compounding of your investments can be more effective since the returns will be higher. Hence, daily compounding is preferred by most investors as compared to monthly compounding.
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