‘The Power of Compounding’ is the most important financial concept that many people do not know about yet. It is not only essential for saving and investing, but it also has great potential to create incredible wealth over time if utilized correctly.
This article will teach you how to do that. Some of us are so busy trying to make ends meet each month, we forget about the long-term effects this may have on our future. This has the potential to change the way you look at investing, so read on.
What is Compounding?
Compound interest is a type of interest that accumulates over time. The interest is added to the principal and reinvested so that more interest is earned on previous interest.
For example, if you have an account with a 10% annual rate of return compounded annually, you will have 1.1 times your initial deposit after one year, 1.21 times your initial deposit after two years, and so on.
Let us understand this with an example.
Suppose you invest Rs 10,000 for 10 years at a simple interest of 6% per annum. At the end of every year, you take out the interest that you receive.
So, the interest you will earn in 10 years will be Rs 6000.
Option 2: Compound Interest
In this case, you make the same investment as before, but you do not take out the interest every year. In other words, you re-invest the interest to make your investment larger.
As you can see, here you have earned Rs 7908.48, i.e., Rs 1908.48 extra!
This has been possible only because you resisted your urge to take out the interest every year and re-invested it. The (principal + interest) amount kept growing and you got extra interest on interest.
How does this concept relevant for all our investments?
If you have ever used a bank or credit card for borrowing, you’ve been exposed to compound interest already. That’s because the rate is applied to the principal amount as well as any accrued interest, which means that your debt grows exponentially over time.
The same principle applies to investments as well. You can obtain investment returns that are compounded, meaning that the interest is applied not only to the principal but also to the dividends, which are the earnings from your investment.
In other words, compounding interest is a way of earning interest on the principal and also on the accumulated interest in an account. Compounding can be thought of as a daily, weekly, monthly, or yearly addition of profits to the principal.
Hence, the power of compounding is a great way to grow your money. It is also very easy to understand why compounding can make one very wealthy if they start early in life and continue to add money to their investment over time.
How can you take advantage of the power of compounding?
No matter what stage of life you are in, it’s important to start saving for retirement. One way that you can do this is by investing your money so that it grows over time.
The average person may not know how compounding works, but it can make a huge difference in any long-term savings and investment strategy. More specifically, compounding refers to the idea that earnings from investments grow over time rather than being taken away from the investor.
Golden Rules For Building Wealth
The power of compounding works like a magic, but unfortunately, few people understand its power. Now that you have understood how powerful this concept is, let me give you some golden rules of taking advantage of it for building your wealth.
- Start investing early
Investing early in life can lead to significant financial gains. The earlier you start investing your money, the longer you’ll have to save, and the more will be the compounding effect on it.
So, there is no right or wrong time to start investing. If you have not started, the right time is now!
- Be patient
As mentioned earlier, you need to start investing early, and then give your investments the time to grow with the help of the power of compounding.
Compounding works with both dividends and interest (the rate of return on your investment). So, if you continuously buy and sell securities, you will lose out on both, and hurt your portfolio.
Hence you need to have patience and hold on to your investments in order to get the maximum advantage from the power of compounding. Be patient and see the magic happen.
- Invest regularly
The power of compounding is all about using your money to make more money. If you invest a little bit of money each month, it will grow more and more as the months go on. It’s easier than you think.
With a bit of time and a little bit of planning, you can use your money to make more money than you could with any other investment.
I hope that by now you have got a clear idea about what compounding of money is and what its benefits are. The power of compounding can make you super-wealthy, so take advantage of it as much as possible.
Keep investing regularly and be patient, so that the power of compounding can lead you to financial freedom!
Happy Investing!
This article is for education purpose only. Kindly consult with your financial advisor before doing any kind of investment.