What is the power of compounding?
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Back in school days, while calculating the problems based on compounding, everyone must have thought about using compounding in life. Now that we are adults, the concept of compounding has become much simpler and easier to understand. But what does the power of compounding actually mean? The power of compounding is analogous to a small seed that grows into a beautiful flower by multiplying itself with every drop of water it receives. In simple terms, compounding allows you to yield high returns on your savings and investments while helping you plan your life goals. Read on to find out how compounding actually works.
What is the Power of Compounding?
The compounding power refers to the process of multiplying your interest, which means creating wealth from the amount invested. It works on two principles, including the initial principal amount and the accrued earnings from the previous compounding period. In India, banks and financial institutions provide broad options for investment to let you earn compound interest on your investments. Usually, an individual can invest their money for a definite period, such as an annual, monthly, or daily period, to gain the benefit of compounding according to their needs.
How Does the Compounding Power Work?
Investing money is not an easy task, even if you are investing in assets that provide compound interest. Compound interest can help you make money over time only if the funds are allocated correctly. However, in cases of improper investment planning, your debt accrues compound interest, which may create a financial burden for you. So, here's how to use the power of compounding to make the most of your investment.
The process of compounding interest begins once your investments accrue interest. At this stage, the interest received is included in the initial investment amount. Therefore, when the investor earns interest again, the newly accrued interest will be determined by calculating the initial capital invested and the earned interest. Therefore, the interest will be added to the total investment amount as the size of the investment increases. This cycle will continue, allowing the investment to grow significantly without any additional investment capital. In the long run, you can grow your investment beyond your imagination.
For instance, if you invest Rs. 1,00,000 each year with a 5% compound interest rate. After 5 years, your investment will grow to Rs. 5,80,000. Furthermore, if the return rate increases to 8%, your amount of investment will increase to Rs. 6,34,000.
How to Earn Maximum Profit with the Power of Compounding?
A smart investment will let you enjoy smart gains on your investment. Here are the golden rules you can follow to maximize your profits with compound interest.
- Invest at Early Age:
As soon as the first salary is credited to your account, you must begin investing. In the long run, whether you want to buy a house or start your own business, the wealth created through compound investment will help you achieve all of your goals. Besides, if it is not necessary, it is suggested that you not withdraw the funds to yield higher returns.
- Short-duration Compounding:
Another key factor that can make you profitable is choosing the frequency at which the interest multiplies. In India, an investor can choose from various durations, including, weekly, monthly, annual, and quarterly. The shorter the duration of compounding, the more investments would be highly profitable.
- Goal-oriented:
Before investing your money, define your goals properly. Simply put, knowing the vision for your planning will allow you to take a step back from withdrawing funds in the interim. Plus, goal planning would be an advantage in understanding the duration of your investment plan.
- Invest Regularly:
You can keep your portfolio healthy by investing regularly. Regardless of whether you earn more or less, invest 10% of your salary every month to achieve your financial goals in the long term.
Conclusion
The power of compounding is highly beneficial for maximizing savings and investments. You can accomplish your long-term goals by investing early in life. Staying invested for a longer period of time will make the power of compounding much more advantageous for you. An individual can invest in fixed-income and market-linked instruments to reap the benefits of compounding. Apart from savings and investments, compound investments provide tax benefits on investments under Section 80D.
