How compound interest grows your money over time
What's the story
Compound interest is a powerful financial concept that can greatly boost your savings/investments over time.
Unlike simple interest, which is calculated only on the principal amount, compound interest accumulates on the initial principal and the interest accumulated in previous periods.
This means your money grows at an accelerating rate, making it a valuable tool for long-term financial planning. Here's how it works.
Compounding
The power of compounding
Compounding works by reinvesting the interest you earn back into the principal amount, allowing your investment to grow exponentially over time.
For instance, if you invest ₹1,000 at an interest rate of 5% per annum, after one year, you will have ₹1,050.
In the second year, you earn 5% on ₹1,050, not just on ₹1,000. This cycle continues every year, leading to massive growth in your investment.
Duration
Time: The key factor
The longer you allow your money to compound, without withdrawing, the more pronounced its growth will be.
The earlier you start, the more time your investments have to take advantage of compounding effects.
For example, investing ₹1,000 monthly at 6% annual return for 30 years gives you much higher returns than starting 10 years later with larger monthly contributions, due to the longer compounding period.
Scenario
Frequency matters
The frequency with which interest compounds also impacts how much money you accumulate over time.
Interest can be compounded annually, semi-annually, quarterly, or even daily.
More frequent compounding results in higher returns because each compounding period adds additional earnings onto previously accrued amounts faster than less frequent intervals would allow.
Selection
Choosing suitable investments
Choosing the right investment vehicles is key to making the most of compound interest.
Different options provide different rates and frequency of compounding, depending on factors such as risk appetite, prevailing market conditions, and economic trends.
These aspects affect certain sectors of the global markets today, which is why it's important to choose investments that suit your financial goals and risk appetite.