Power of Compounding

Power of Compounding

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Understanding the power of compounding in market investments

Key Takeaways

  • Power of Compounding refers to reinvesting the accrued profits.
  • The interest earned on the principal amount is reinvested, thus increasing the principal amount.
  • Compounding assists with maximising the returns on investment.
  • Stay invested in Mutual Funds schemes with growth options to enjoy compounding benefits.
  • Use power of compounding calculators to compute your returns.

We invest to beat inflation and maximise our returns on investment. As an investor, you can leverage various time-tested strategies to get the best returns on investments. However, if you prefer to earn returns the old-fashioned, effective way, you can consider the compounding strategy. With compounding, your investments give you the best returns, and the interest earned keeps earning interest. Read on as we decode the power of compounding.

What Does Power Of Compounding Mean?

Before talking about the power of compounding, we need to understand its foundation – compound interest. Compound interest means the interest calculated on the principal amount and the accumulated interest. Investments like mutual funds or stock markets earn profit based on compounding, hence the phrase, power of compounding.

How Does Power of Compounding Work?

Let us say that you invest INR 1000 in an investment scheme with a 10% average rate of returns. Your returns would be INR 1100. Instead of redeeming the profits, you keep them invested for a long time. The 10% rate would be applicable on INR 1100, where you earn INR 1210. The longer you keep investing, the better compounding works.

Compound Interest Vs Simple Interest

While compound interest offers returns on returns, simple interest provides interest on the initial principal amount only. For instance, say your investment amount is INR 1,00,000 for 5 years at an expected return rate of 10%. Consider the below table to understand the interest accrued.

 

Compound Interest

Simple Interest

Year

Principal

Interest Rate

Interest Amount

Yearly Compounding

Principal

Interest Rate

Interest Amount

Total At Year End

1

100000

10%

10000

110000

100000

10%

10000

110000

2

110000

10%

11000

121000

100000

10%

10000

120000

3

121000

10%

12100

133100

100000

10%

10000

130000

4

133100

10%

13310

146410

100000

10%

10000

140000

5

146410

10%

14641

161051

100000

10%

10000

150000

   

61051

   

50000

 

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Power Of Compounding in Mutual Funds

Growth Mutual Funds reinvest the yields from the underlying scheme. Interest is compounded monthly, quarterly, or half-yearly, depending on the Mutual Fund scheme. For instance, with the power of compounding in SIPs, if you opt for a monthly SIP, your returns will be compounded monthly, generating higher returns in the long term as opposed to lumpsum investments.

The Benefit Of Starting Early

The earlier you start investing, the more you allow your investments to grow. For instance, if you invest INR 10 Lakhs with a 10% expected return rate in 2021, your investment will amount to INR 27 Lakhs in 10 years (by 2031) and INR 73 Lakhs in 20 years (by 2041). You can use online power of compounding calculators and input various permutations and combinations of the principal amount, interest rates and investment period to compute your estimated returns.

Final Note

Compounding works on the fundamental notion that your interest earns interest. The power of compounding in stocks and Mutual Funds mainly helps maximise your returns significantly than through any other investment.

Are you interested in securing your financial future? If yes, then download the digibank by DBS app and start investing in mutual funds. You can choose from over 200 of the top-rated schemes*C

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*Disclaimer: This article is for information purposes only. We recommend you get in touch with your income tax advisor or CA for expert advice.

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