07 Feb 2022

# Power of Compounding

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

## 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 DBS Bank app and start investing in mutual funds. You can choose from over 200 of the top-rated schemes*C. Also, open your savings account with us.

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