Q. Why is the compounding effect known as 8th wonder of the world? How can people use the power of compounding to the maximum for their investments? Gaurav Bhatia
A. Compounding works as a wonder when you make long-term investments. The greater the time you remain invested, the bigger your corpus will grow through the power of compounding.
Compounding investment means investing the return again and again to grow the principal amount and build a bigger corpus at the end of the tenure. For example, you invested Rs.10,000 at 12% interest p.a. which is compounded monthly. So, at the end of the first month you’ll earn an interest of Rs.100 which will be added to your principal to make it Rs.10,100. In the next month, your interest income would be Rs.101, which will again be added to the principal to make it Rs.10,201. Similarly, the process will continue till the maturity of the investment.
Longer investment periods result in bigger corpuses under the compounding scheme. For example, suppose you invested Rs.2 lakh at the age of 20 years for a tenure of 30 years at 10% interest with quarterly compounding. At the end of the 30-year period, you’ll get Rs.38.72 lakh. Now, suppose you had invested triple the amount, i.e. Rs.6 lakh but for half of the original tenure, i.e. only for 15 years, then at the end of the tenure you’ll get Rs.26.4 lakh. It shows that the power of compounding can grow your corpus manifold if you invest for a longer tenure.
So, if you want to make full use of compounding returns, start investing early in your career. Invest for long tenures and invest regularly, and most importantly, don’t disturb the corpus till the maturity.
Have a question on personal finance? Ping me on Twitter at @adhilshetty with the hashtag #AskAdhil. The writer is CEO, BankBazaar.com, an online marketplace for loans and credit cards.