The Power Of Compounding

Aug 10, 2022

Many of us might have read in school about the idea of compound interest. We don’t grasp the significance of compounding until we manage our finances as adults.

Understanding compounding can help you plan for significant milestones in your life. It will also increase the return on your investments and money. The “snowball effect” illustrates how a small snowball grows larger as it rolls down a hill. It is a reasonably appropriate example to grasp the idea of compound interest. 

By adding more interest (or capital gains) to your principal and accrued interest, the power of compounding boosts your savings. 

What is Compounding?

In essence, compounding is the act of “adding interest on interest”. This means that the amount of money you invest will result in returns from both the initial capital and the collected earnings from earlier compounding periods. Thus, compounding helps in the rapid growth of your wealth.

Leading financial institutions in India provide various investment options that give compounded returns.

Magic of Compounding

Consider making an annual investment of INR 1 lakh in a plan that pays a 5 percent compound interest rate. Your total investment of INR 5 lakhs will be worth INR 5.80 lakhs after five years. The future value will increase to INR 6.34 lakhs if the rate of return rises to 8%. Consider making the same annual investment amount, INR 1 lakh, for ten years instead of five years and at an 8% interest rate. Your maturity amount will be INR 15.65 lakhs. If you increase the investment period to 15 years, keeping all other variables constant, your maturity amount will jump to INR 29.32 lakhs. The longer you remain invested, the higher your returns will be, owing to compounding. 

You can use a compounding calculator to understand how your returns change across various investment periods and rates.

Remain Invested for a Longer Period

The most amazing compounding feature is that your assets generate interest on the initial investment and interest accrued during earlier compounding periods.

Thus, as an investor, you must remember that compounding’s strength resides in its capacity to reinvest returns on your investment. In other words, before the investing time is over, you shouldn’t try to withdraw your earnings if you wish to maximize your returns.

Otherwise, you risk restricting the power of compounding’s ability to grow your income. Thus, your financial objectives and investment capacity should be considered when choosing an investment strategy and time frame. To have enough time to amass the appropriate quantity of money, you must start investing as soon as possible.

How To Improve Your Savings with Compounding Benefits?

1. Make an Early Start

To maximize the power of compounding, you must start your investments early. Compounding will enable your savings to expand to a higher maturity amount if you start investing your money as soon as you start earning.

The longer you hold onto your investments without taking any money out of your returns, the more room you give your money to grow. It’s because compounding’s power grows over time.

With a longer investment horizon, time is on your side, and your investments will generate more interest.

2. Go for Shorter Intervals of Compounding

The frequency at which the interest multiplies is another component of compounding’s strength. In India, several investment alternatives provide a range of compounding frequencies.

Your returns will generally increase more when you increase the reinvesting (or compounding) frequency. If you choose a plan with quarterly frequency, the interest is compounded four times a year. Similarly, the interest is compounded twice in a plan with semi-annual frequency. Using a compounding calculator will also help you comprehend how the power of compounding can boost your returns through various investment durations and interest rates.

3. Be Patient

Prioritizing your investments and exercising discipline are prerequisites for building a strong and profitable investment portfolio. Also, you must maximize your assets by utilizing the power of compounding. Regardless of your income level, you must set aside time to determine your preferences and goals.

At the same time, you should not be persuaded to take premature withdrawals that could harm your fund’s ability to develop. So instead of focusing on obtaining immediate profits, you should give your investments enough time. This is important to build large sums of money thanks to the force of compounding.

4. Choose the Right Instruments

You may not be as financially astute as an experienced investor. But, that should not make you believe that the power of compounding is not for you. You can find it challenging to invest primarily in stocks. It’s because they are a volatile asset class and don’t provide any return guarantees.

However, the upside of stock investments is that they outperform all other investment opportunities in terms of long-term inflation-adjusted returns more often than not. If you remain invested long enough in equities with healthy financials, the power of compounding can give you strong returns from the stock market.

Also, while trading with equities, you can limit your losses by choosing a stop-loss strategy. With the stop-loss approach, you can pre-order the selling of a stock at a particular price. To take the advantage of compounding, you can diversify your investment. You can diversify among various market capitalizations and industry sectors.

5. Invest in Fixed Return Schemes

You can maximize your returns by investing in equity mutual funds and direct equities. But, these investments are also susceptible to market volatility. As a result, it is advisable to search for other investment options that provide more higher, compounded returns. If you are not inclined to make high-risk investments, this is the strategy to go with.

Debt funds give you access to fixed interest-generating securities like corporate bonds and commercial papers.

National Pension System (NPS) is a long-term retirement-focused investment opportunity. It enables you to capture compounding benefits through government fund investments. It is an effective tool that exploits the power of compounding.

Peer-to-peer lending is another long-term investment opportunity that lets you build wealth through compounding. P2P lending platforms like LenDenClub offer you up to 10-12% per annum* returns, making it one of the best investment opportunities. The platform’s hassle-free mechanism powered by artificial intelligence reinvests your money to give you compounded returns if you choose to remain invested. Invest Now!

Conclusion

Compounding’s great advantages allow you to maximize your assets and savings. It supports your long-term financial goals. Making an early start and being patient with your investments will help your investments’ ability to expand. To enjoy compounding, you must stay invested for a long time. Many investing opportunities in India offer compounding gains.

*P2P investment is subject to risks. And investment decisions taken by a lender on the basis of this information are at the discretion of the lender, and LenDenClub does not guarantee that the loan amount will be recovered from the borrower.

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