How the Power of Compounding Interest Can Make You Rich?

It is believed that Albert Einstein once said that compounding interest is the eighth wonder of the world. We can’t confirm if he actually did say this or not, but if he did, he wasn’t far from the truth.

Imagine this: You have a bar of your favorite chocolate in the fridge. You don’t eat it today and when you open up the fridge tomorrow, there are two bars of chocolate. Interesting, right? You still don’t eat any of the chocolates and the next day, there are three chocolates in the fridge.

Sounds like magic, doesn’t it? Well, this is how compounding interest works and it is no less than magic. 

Compounding interest is when you earn interest on your interest. In comparison, simple interest is when you earn interest on your investments alone.

For example, let’s say you invest Rs. 100 and earn a 10% interest on it in a year. So, at the end of the first year, you will have Rs. 110. Now, if you leave your investment as it is, in the second year, you will earn 10% interest in not only the invested Rs. 100 but the Rs. 10 worth of interest earned earlier as well. That is -- you will earn interest on Rs. 110. 

This is how compounding interest helps you gain by allowing you to earn more as you stay invested. This might seem insignificant for a period of 1 or 2 years, but the real magic begins when you invest for a long period of time.

Let’s say you invest Rs. 10,000 every year for a period of 5 years. If you earn 10% compounding interest on your investments, here’s how the magic will unfold to hike up the value of your invested Rs. 50,000.

Thanks to compounding interest, your Rs. 50,000 grew to Rs. 67,156. You earned interest worth Rs. 17,156. If you had earned simple interest of 10%, you would have earned just Rs. 5,000 on your investments. 

Compounding interest helped you earn Rs. 12,156 more!

But this is just the start. More magic happens when you not only invest every year but increase your investment amount as well. Investment experts, after all, recommend that you increase the amount you invest every year.

Your salary or your income goes up every year, which is why your quantum of investment should go up as well. Another reason is that inflation also goes up every year. Hence, it helps when your investments are also earning for you.

See how the magic of compounding interest unfolds when you increase your investments by 10% year on year.

The Rs. 61,051 you invested over 5 years turned to Rs. 80,525, which is an interest earned worth Rs. 19,474. Here, simple interest would have gotten you Rs. 6,105 only!

Here's a graph to explain the difference between Simple and Compound Interest

Yes, compounding interest is magical. But it’s not magic that will happen overnight. 

Compounding takes its own time to turn fruitful. You need to do the following two things to benefit from compounding interest:

• Start early: If you’re young, you have time on your side and the power of compounding needs nothing else more than time to flourish. Start investing as early as you can. But of course, if you haven’t started yet, you can start now. It’s never too late.
  
  Learn how to get started here: 5 Steps to Achieve Financial Freedom
  
  
• Stay at it: Successful investors are patient investors. Even when the going is tough, when the markets are turbulent, the best thing you can do for yourself is not only stay invested, but also continue investing.
  
  Learn more about long-term investment here: What Is Long-term Investing and Does It Really Work?

Remember: investing is a marathon, not a sprint. And compounding interest is the ally that will help you reach the finish line and beyond with ease.