What is the power of compounding?

Mathematically speaking, compounding is defined as, ‘the increase in the value of an investment, due to the interest earned on the principal, as well as the accumulated interest.’ 

Simply put, it is a strategy that makes your money work for you. It could be regarded as a powerful tool to grow your wealth. You can use the power of compounding to plan your future goals, such as retirement. 

Simple interest means you earn interest on your principal. But with compound interest, you earn interest on the principal amount as well as the accumulated interest amount over successive periods. Over time, this interest snowballs into a substantial amount. 

Here’s a hypothetical example to highlight the power of compounding. 

Vijay and Geeta both invest Rs 50,000 each in an investment avenue that offers an annual interest rate of 10% for 10 years. While Vijay chooses simple interest, Geeta opts for compound interest (read re-invest). 

At the end of 10 years, Vijay would make a total corpus of Rs. 1 lakh. On the other hand, Geeta would earn a corpus of Rs. 1.30 lakh. 

This is because in Vijay’s case, the interest was calculated only on the initial principal amount of Rs. 50,000. But in Geeta’s case, the interest earned each year was included along with the principal to calculate the interest for the next year. This helped increase her earnings in a big way.