What is Power of Compounding
You may have often heard about how investors benefitted from the power of compounding. But do you know what it is? Read on to find out more about it.
What is Compound Interest?
In simple words, when interest is added to the principal amount as well as the interest it is called compound interest. In compound interest, the interest accumulated over a period is added to the principal amount, and the interest for the subsequent term is calculated on the new amount, which includes both the principal amount and the interest of the previous term. This process is repeated through the investment term.
Important facts to know about compound interest
- If you want to know precisely how much returns will you earn from your investment, you can use the online compound interest calculator and get an accurate estimate.
- The online calculator is easy to use, and several sites have customised it so that the users can fill the details and get instant results. You have to enter the amount invested, the rate of interest applied, the duration of the investment and the calculator will show the exact returns for the said period.
- The potential of earning and increasing your wealth is enormous with compound interest. If you have made an investment that offers a compound interest of 6% per annum, it will double in 12 years. Assuming the interest rate does not change, your investment will grow four times in 24 years.
- If you are an amateur investor and have invested in any instrument that offers compounded returns, you may feel that the returns are not significant initially. But, if you stay invested for long-term, even if the interest rate is 5% with compound interest applied every month, your investment will grow significantly in 10 or 15 years. The best part is, your investment will grow without adding any additional amount to your existing investment.
- Another significant benefit of compound interest is that you need not be an expert or a financial analyst to know how to increase your savings through compound interest. If you invest smartly and keep depositing in your savings account, over the years, your savings will grow to a large sum. Also, experts recommend choosing investment tools that offer compounded returns every quarter rather than annually.
- Compound interest has many advantages while you are investing and trying to build a corpus. But, it can be a major drawback if you have to pay compounded interest on your debts. If your credit card company charges a compounded interest, the debt can quickly escalate, and you may have to pay a hefty charge. So, be careful and meticulous with your payments and do not let your debts mount.
How to take maximum advantage from the power of compounding?
As an investor, you would want your savings and investment to grow quickly, and there is no better way than choosing the right investment tools that offer compounded returns. To maximise your potential profits, experts recommend, you must develop the following habits.
The earlier you start investing, the better as it allows you to take advantage of the time to let your money grow. The longer you stay invested, higher will be your potential returns, and the risk gets reduced. So, to take maximum advantage of the power of compounding, it is advisable that you start investing as soon as you receive your first salary.
Be disciplined with your investment
Being disciplined implies that you must invest a small amount regularly and keep monitoring the funds periodically. You must be proactive and have a meticulous investment strategy.
Even if you have invested in an instrument that offers compound interest, your savings will not grow overnight. You must remain patient and think long term. Also, you must not take any impulsive decisions and react to the sudden changes in the market conditions.