How to use compound interest to grow your money
What's the story
If you want to grow your savings, understanding compound interest is a must. This basic finance concept can make a huge difference to your savings or investments over the years.
Unlike simple interest, which is calculated only on the principal, compound interest is calculated on the principal and the accumulated interest.
This way, your money grows at an accelerating rate.
Fundamentals
The basics of compound interest
Compound interest is basically earning or paying interest on previously earned or paid interest.
Let's say you invest ₹10,000 in a savings scheme that offers an annual interest rate of 8%, compounded yearly.
In the first year, your money grows to ₹10,800. In the second year, interest is calculated not on ₹10,000, but on ₹10,800—and so on.
Each year, you earn interest on a slightly larger amount, and over time, that growth becomes exponential.
Savings insight
Savings accounts and compound interest
Some savings accounts provide compound interest as an incentive to save money over a period of time.
If you deposit ₹50,000 into a savings account with 4% annual compound interest and make no further deposits or withdrawals, you would have approximately ₹60,800 after five years
This is how even the small amounts can grow when they are left untouched in a compounding environment.
Loan dynamics
Loans and compound interest impact
Compound interest also has a critical role in loans like mortgages or student loans.
When you borrow money with compounded rates, you end up paying more than you would with simple interest (considering charges are accumulated on both the principal and accrued interests over the period).
Understanding this can help you plan better for repayments by considering total costs instead of just monthly installments.
Investment strategy
Investment growth through compounding
Mutual funds usually capitalize on the power of compounding to accelerate investors' portfolio growth over time.
By reinvesting dividends into purchasing more shares, instead of cashing out, investors enjoy future market gains on their initial capital.
This approach results in higher wealth accumulation compared to non-compounded options across asset classes worldwide.