Power of Compounding

Open a DBS Bank Account Now

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 what is 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.

Advantages of Compound Interest

Compound Interest allows your savings and investments to grow faster due to interest accumulation over time. The advantages of compound interest for different financial products are:

• Systematic Investment Plans (SIPs) – With SIPs you invest a fixed amount of money into your preferred mutual funds. Your monthly investment grows through reinvesting the earned amount form the investment over time. To get a better estimate for power of compounding in SIP, you can use a SIP compound interest calculator which shows the benefits of compounding in long term.
• Mutual Funds - The power of compounding in mutual funds investment comes from reinvesting the profits on your purchased units into the funds. Over time, compounding creates a snowball effect which significantly increases your wealth.
• High-Yield Savings Account – If you have a high-interest rate savings account, your balance grows steadily over time. It can be ideal for building an emergency fund or saving for short term goals as the funds remain liquid while benefiting from power of compounding. DBS Bank offer savings account with interest rates of up to 5.5% p.a. The interest is calculated daily with quarterly payouts, making It an ideal choice for growing your wealth.
• Fixed Deposits (FDs) - With fixed deposits help grow your money steadily by applying compound interest on the invested amount. Choosing a longer tenure or a higher FD interest rate can significantly increase your final amount, making it a safe and effective tool for long-term savings and wealth preservation.
• Recurring Deposits (RDs) – These deposits allow you to invest a fixed amount monthly. Each deposit earns interest that compounds over time, increasing your total maturity value. This disciplined savings tool is ideal for planning future expenses while taking advantage of compounding to maximise returns without requiring a large lump sum investment upfront.

Power of Compounding Formula & Examples

To get a better understanding of compound interest it’s important to understand how compound interest is calculated. Here’s brief look at the compound interest formula with example.

Compound Interest Formula Explained

 To calculate compound interest formula you can use this formula:

A = P(1 + r/100)n – P

Where:

• A = Final Amount
• P = Principal (initial investment)
• R = Annual interest rate (in decimal)

Example of Power of Compounding

Suppose you invest INR 1,00,000 at an annual interest rate of 8%, compounded yearly, for 10 years.

Using the formula:

A = 1,00,000 × (1 + 0.08)10 = INR 2,15,892

Here, compounding nearly doubles your investment without any additional contributions, showing how staying invested for longer significantly enhances returns.

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 if the interest rate is set at 10% per annum.

After five years compounding grows your INR 1,10,000 balance to INR 1,61,051 compared with a simple interest total of INR 1,50,000 so you earn INR 11,051 more, which is about 10% higher returns on the same principal without any additional investment required.

Open a DBS Bank Account Now

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. To begin your journey toward long-term wealth creation, you can open a savings account online that offers high interest rates, making it easier to grow your money while enjoying the convenience of digital banking.

Common Mistakes to Avoid While Using Power of Compounding

The power of compounding can transform even small savings into substantial wealth over time. But to truly benefit, it’s important to avoid common pitfalls that reduce its effectiveness. If you’ve ever asked what is power of compounding, understanding these mistakes is just as important as knowing how to apply it.

1. Starting Late

The earlier you invest, the longer your money has to grow. A delayed start limits the power of compounding, even if you invest larger amounts later. Use a power of compounding calculator to see how much a few early years can add to your total corpus.

2. Withdrawing Too Early

Compounding works best over time. Withdrawing returns or stopping your investment midway interrupts the cycle, limiting growth. For example, pulling out from a long-term SIP too soon reduces the impact of compound interest accumulation.

3. Inconsistent Contributions

Irregular investing weakens the compounding effect. Whether it’s mutual funds, FDs, or RDs, consistency is key. Regular investments allow interest to compute savings interest over a growing principal, maximising returns.

4. Focusing Only on High Returns

Choosing investments based only on high returns can backfire. Stability and time matter more. The power of compound interest shows its full potential in steady long-term products, even if interest rates seem modest.

5. Not Reinvesting Earnings

To fully benefit from compounding, always reinvest interest or dividends. Growth-oriented mutual funds and cumulative FDs are excellent power of compounding examples that show how reinvested earnings accelerate wealth creation.

Final Note

Compounding works on the fundamental notion that your interest earns interest. This powerful principle significantly boosts returns, especially when investing in stocks and Mutual Funds. To make the most of your savings, you can now open a bank account online with DBS Bank.
With attractive high interest rates and smart mobile banking features through the DBS digibank app, it's easier than ever to grow your wealth efficiently and conveniently.

Open a DBS Bank Account Now

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