The great Albert Einstein once said “The most powerful force in the universe is compound interest“. So what is this compounding all about and what is so special about it to get such a compliment from the great scientist? Lets try to understand.

Compounding is the concept of adding accumulated interest back to the principal, so that interest is earned on interest from that moment on. In other words, compounding refers to generating earnings from previous earnings. With simple interest, you earn interest only on the principal (that is, the amount you initially invested); with compounding, you earn interest on the principal and additionally earn interest on the interest.

To understand better, lets take an example. Suppose you invest Rs. 1000/- per month for say 30 years. Your total investment would be Rs. 3.6 lacs. Assume the rate of return is conservative 9%. The power of compounding will grow your total investment of Rs. 3.6 lacs to Rs. 17.02 lacs.

Compounding works best when you give it more time. Assume we increase the time period in the above example from 30yrs to 40 yrs, the return would increase from Rs. 17.02 lacs to Rs. 42.19 lacs! This shows the multiplier effect of compounding. The longer you let your money stay untouched, the faster and bigger it grows.

Now that you’ve understood the power of compounding, lets see how you can make that power work for you. Compounding will work for you if you:

  • Start early
    The younger you start, the more time compounding has to work for you, and the wealthier you can become. The next best thing to starting early is starting now.
  • Make regular investments
    Don’t be haphazard. Remain disciplined, and make saving a priority. Do whatever it takes to maximize your contributions. Even small investments made regularly can surprise you some years down the line.
  • Be patient
    Do not touch your investments. Compounding only works if you allow your investment to grow. The results will seem slow at first, but persevere. Most of the magic of compounding returns comes at the very end.

Always remember that every day that your money stays invested is a day your money is working hard for you, helping you ensure a financially secure future.