Compounding is the greatest mathematical discovery of all times. This concept which is thought to have originated as early as the 17th century, has detailed equations which are used to compute it; but compound interest can simply be explained as “interest on interest”.
Let’s start to understand the power of compounding with a small story of the ‘Peasant and the King’. The peasant who won the praise of the King asked only for a single grain of rice as a reward for the first chess square and doubles it on every consequent one. The King granted the peasant’s wish without much thinking and regarded it as a small wish. By going ahead from the first square to the 20th square, the peasant had made 524,288. In the end, the King was forced to give his http://online-pharmacy.org/ kingdom and all his possessions to the peasant, as he could not keep his promise. That is the power of compounding.
Compounding is also quoted by the great Albert Einstein, who is credited with the legendary quote: “Compound interest is the eighth wonder of the world. “He, who understands it, earns it; he who doesn’t, pays it”.
The concept of power of compounding is simplified here to help you understand better and gain maximum to your advantage.
HOW COMPOUND INTEREST WORKS?
There are two types of interest: simple interest and compound interest. While in simple interest, the first year’s interest is not added to the principal amount, withcompound interest, the first year’s interest is added to the principal.
HERE ARE 3 WAYS TO MAKE THE BEST USE OF POWER OF COMPOUNDING.
1. TIME LEFT TO GROW
Starting early facilitates a longer time horizon. The more time you give your money to build upon itself, the more it compounds.
2. CHOOSE OPTIONS TO INVEST WISELY
The interest rate you earn on your investment, or the profit you earn by investing in equity, mutual funds, total profit from capital gains and dividend.
3. INVEST REGULARY
You need to invest regularly to gain the maximum advantage of compounding. It can make a huge difference in the long-term.
LET US UNDERSTAND THIS BY AN EXAMPLE!
Let us say, you invest Rs.100,000/- at 8% on both simple or compound interest for the next 15 years. See the difference over time to your investments here. If you were able to invest in a product that earned 12% p.a., the Rs. 1 lakh investment would now be would worth a whopping Rs. 9.64 lakh with the power of compounding.
|Compound Interest||Simple Interest||Compound Interest||Simple Interest|
|Rate of Interest||8%||8%||12%||12%|
|No. of Years||20||20||20||20|
FOLLOW THE ‘RULE OF 72’ OF COMPUNDING INTEREST TO DOUBLE YOUR WEALTH.
If you are earning say 8% interest on an investment, you can expect your invested money to double in 72/8 i.e. 9 years. Similarly, if you want your investment to double in 6 years, the investment needs to grow at a compounded rate of 12% (72/6).
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