Mustafa Jawadwala explains how compounding can hasten wealth accumulation
Albert Einstein called compounding “the greatest mathematical discovery of all time” that can be applied to everyday life. Compounding refers to the multiplier effect in a long-term investment strategy.
Compound return can be achieved when an investor invests a sum of money regularly for a certain period and the periodic returns too are reinvested which in turn gives additional earnings.
Instead of withdrawing interest earned on the money, it gets added to the principal and the return the next year is earned on the larger amount – principal plus interest. In the subsequent year, the rate of return is on the larger principal sum. The longer the period of investment, the bigger the wealth accumulates.
Compounding works on two basic principles - reinvestment of earnings and period of investment.
Comparison of Simple Interest and Compound Interest
The power of compounding has an amazing effect on wealth accumulation. The table below shows return on Rs 10,000 invested for 10 years to 30 years based on 12 per cent simple interest and 12 per cent interest compounded yearly as well as quarterly.
|
Type of Return |
10 yrs (Rs.) |
15 yrs (Rs.) |
20 yrs (Rs.) |
25 yrs (Rs.) |
30 yrs (Rs.) |
|
Simple Interest |
22,000 |
28,000 |
34,000 |
40,000 |
46,000 |
|
Compound Interest (Yearly) |
31,058 |
54,736 |
96,463 |
1,70,001 |
2,99,599 |
|
Compound Interest (Quarterly) |
32,620 |
58,916 |
1,06,408 |
1,92,186 |
3,37,109 |