The power of compounding has lately been realized and used to utmost advantage by a niche segment of people. There are still so many of us out there who do not understand the power of compounding.
In the words of Albert Einstein, Compound interest is the strongest force in the world. If you fail to understand it, you will have to pay it and if you do, you earn it.
Creating wealth is an art, it does not come with a breeze of luck. One has to earn it with all the conviction and wisdom. Even if you start small, by the time is mature, it is plenty and by plenty we mean it is LOADS. How does all this happen? It is the power of compounding working in the background.
COMPOUNDING AND LONG-TERM INVESTMENT: BENEFITS
Let us begin this by saying, “Sooner the Better”. It is quite understandable that there are times when you are obligated under responsibilities and emergencies but this is not a negligible aspect of life. Securing your later years is often a late realized thing which pinches when the time has passed by.
Compounding is directly proportional to long-term investment. The more you stay invested, the better returns you reap. For instance, Raj is a 22-year-old professional who has started making an investment of, let us say, Rs. 3000 at the interest rate of 8.5%. He plans his retirement at the age of 55 years. This investment which Raj has started making now will reap bigger benefits by the time he retires under compound interest as compared to simple interest. SIP are the method through which when you make investment, the interest gets compounded over time and creates wealth for you. Read more about SIP at https://www.piggy.co.in/blog/what-is-a-sip/
How is that so? This is because, when compound interest is applied, the profits you make annually are re-invested in the principal amount and as a whole gain further interest profit. This process is iterated till the time of maturity which increases the benefits exponentially. Hence, the longer you stay invested, the more you gain.
COMPOUNDING- HOW DOES IT WORK?
Compound interest accelerates the profit earning process by re-investing the earned profit back to the principal amount and using it as the principal amount for the next year.
Lets us understand this by an example,
1. Raj made an investment worth Rs. 10,000 at the rate of 10% in any deposit.
2. Rs. 1000 is the interest Raj gains by the end of 1st year.
3. For the second year, the principal amount for Raj will be Rs. 11,000 which is simply the sum of 1st-year principal and interest gained (10,000 + 1000)
4. The interest gained in the 2nd year will be Rs. 1100 which is 10% of Rs. 11,000
5. By the end of the 2nd year, the total earnings would be Rs. 12,100 and let us say, by the end of 10 years his total gain would amount to Rs. 25,937.
This is how compounding works in the background to make your profits multi-fold.
HOW TO USE COMPOUNDING TO THE BEST?
It is very important to use the power to compounding to our best benefits at the earliest. Here are some key points to use compounding to its best benefit;
1. Start early
As we have already mentioned, the sooner the better. The earlier you start, the bigger are the returns. Also, start early for a longer investment span. Stretch that investment window of yours to a really long time say 40 years or 30 years and realize the oceans of wealth gained.
While you are still young and earning, it won’t trouble you much to take out a small portion from your regular income as compared to starting in the later years when there are tons of responsibilities.
2. Be sincere and regular
There is always an excuse to stop that investment or stick to a particular amount that you started off with. Even if the returns are obvious, people tend to be sluggish when it comes to increasing the investment amount.
This can be resolved by investing through the SIP method. It is a systematic and automatic investment system which allows you to invest every month, a pre-fixed amount to your investment portfolio and averages out the volatility market shows over a period of time.
3. Choose high return instruments
It is very important to choose your investment instrument rightly. Although we Indians have the instinct to go towards 100% safe instruments, the loss is realized at the time of maturity. If you happen to invest Rs. 1,00,000 in a bank Fixed Deposit at the interest rate of 7% for say 20 years, you will be awarded Rs. 3,87,000 at the time of maturity.
Whereas if you choose an instrument with almost 14% interest rate an invest the same amount for 20 years, you are awarded Rs. 13,74,000.
The difference is 10 times which is quite evident. Hence, be very careful where you invest your money.
4. Endurance is the key
Stay calm and patient. Do not panic if there are temporary market lows. They will fade away soon and if in case you happen to incur any loss, it will be averaged out in the long-term. A high is bound to come after a low. That is how the market works and your money grows. Be assured of the compounding working on your money.
5. Cultivate a habit
With this initial investment, commit to yourself a habit of investment for a better and wealthy future. Start investing and stay invested.