Power Of Compounding
With compound interest, the interest that you earn increases with the increase in your investment (monthly/quarterly/semi-annual/or annual investment plus the interest that you are earning on this investment). This calculator will help you calculate the worth of your investment after a set number of monthly investments or even a single, initial investment, based on the interest accrued on the invested amount.
Scripbox can help you invest in the best mutual funds to grow your money.
What is compounding and why it is one of the most effective ways of increasing your wealth?
In school we all studied the difference between simple interest and compound interest. With compound interest, let’s say, for one year, you have invested Rs. 1000. This is your principal amount. Suppose you’re getting 8% interest for a year. If you invest on December 1, 2019, then by November 30, 2020, you will have Rs.1000 plus 8% interest = Rs. 1080.
Instead of spending the money, you reinvest it. But for the cycle December 1, 2020-November 30, 2021, your principal amount is going to be Rs. 1080 and with 8% annual interest, by November 30, 2021, you will have Rs.1080 plus 8% interest = Rs.1166.4.
If you have invested for 20 years, with compound interest, your initial investment of Rs.1000 will grow to roughly Rs. 4950. This is just when you have invested Rs.1000, initially, and practically forgotten about it. This is a simple way of compounding. In the real world, compounding can be more complex.
Frequently Asked Questions
What is the power of compounding in a Systematic Investment Plan (SIP)?
In a Systematic Investment Plan you invest a fixed sum of your savings every month (or chosen period) instead of making a big investment in a single go. Compounding is how an investment grows much more than would seem possible and why long term investing creates wealth.
The benefit of compounding is, the older an investment the more it grows over time. When you start a SIP, your oldest investment grows the most thanks to dividend additions and bonus issues (in case of growth options of equity mutual funds) as well as growth in the value of the underlying stocks or securities over time..
This way, without causing yourself a financial constraint, through compounding, you can create significant wealth by investing a little bit every month with an SIP.
Here’s a video that explains this in detail
How do you find the power of compounding?
In compounding investment, you earn an interest both on the initial principal and the accrued interest. You can make an investment for a shorter period and a longer period. To calculate compounding, you need to calculate the difference between the short-time investment and the long-time investment.
Since, in compounding, the principle on which your interest is being calculated is constantly changing, manually calculating the power of compounding, especially when multiple timeframes are involved, may be tedious, and even prone to errors. This is why, it makes sense to use our compound interest calculator.
All you need to do is,
- Enter the amount of investment you can make on a yearly basis.
- Enter the number of years you want to invest for.
- Enter the expected annual rate of interest.
Suppose you use the compound interest calculator and enter 20 years. You note down the calculation. This is the first calculation.
While keeping the yearly or monthly investment and the expected annual rate of interest the same, just change the years from 20 to 10. You note down the calculation. This is the second calculation.
When you subtract the second calculation from the first calculation, you find the power of compounding.
What is the magic of compounding?
The magic of compounding is found in the aspect that the initial returns that your investment makes also become a part of your invested capital. This way, you are constantly earning interest on a bigger principle than you initially invested. This is contrary to what happens in simple interest and even in fixed deposits.
In compounding, even if you make a single investment at the beginning of the investment cycle (say, 20 years), the principal used to calculate the interest for the current year is always greater than the principal of the previous year because now, the interest is also added to it.
- In the beginning of 2019, you invest Rs. 100 with 8% annual interest. Here, your principal amount is Rs. 100.
- Assuming that you make no further investment on your part, in the beginning of 2020, 8% is added to Rs. 100 and now your principal amount is Rs. 108.
- In the beginning of 2021, 8% interest is calculated on Rs. 108.
- … and so on.
How do I calculate compound interest return?
Compound interest can be calculated with a simple formula.
An investment of Rs 1,00,000 for 5 years at 12% rate of return compounded annually is worth Rs 1,76,234.
From the graph below we can clearly see how an investment of Rs 1,00,000 has grown in 5 years.
In compound interest one earns interest on interest. Therefore, the investment already includes all the previous interests. And interest is paid on that.
By understanding the importance of compound interest and acting on it by investing in appropriate investments, one can achieve high returns.
What is 15*15*15 rule of a mutual fund?
The 15*15*15 rule of mutual funds means that if you invest Rs. 15,000 every month for 15 years for an annual compound interest rate of 15%, by the end of the investment period, you will have Rs. 1 crore with you against your total investment of Rs. 27 lakhs.
Why is 72 the magic number when it comes to doubling your money?
By using the rule of 72, you can find out how many years it will take to double your investment in a mutual fund. Although, this rule doesn’t give you a definitive answer, it gives you a roundabout figure and then accordingly, you can make an investment or formulate an investment plan. If you know the annual rate of return, you multiply 72 by your annual rate of return and you can get the number of years needed to double your investment.
In simple terms, if R is your annual rate of return, then
Number of years needed to double your investment = 72/R
As you can see, this is the calculation just to play around for your planning. With an objective of doubling your investment, once you know how much you’re going to invest and how much annual rate of return you are expecting, you can have a roundabout figure of how many years it is going to take.
Here’s a video that explains the rule of 72