According to Albert Einstein, Compound Interest is “the greatest mathematical discovery of all time.” Here’s why we think that he may well be right.
Compound Interest has the magical ability to generate high returns even from modest savings. It is one of the methods to get rich over a period of time – a much faster method. It is quite straightforward: If you want the most return on your savings or investments, you want compound interest.
Amongst the two types of interest you can earn, Simple Interest is paid only on the money you save or invest (the principal), while Compound Interest is paid on your principal plus on the interest you have already earned.
Here we have an interesting chart, courtesy JP Morgan, that shows how returns from savings of 10 years can far outweigh returns from 30 years of savings – with the difference being only in the type of interest.
This is how Compound Interest works:
Let’s say you invest today Rs. 10,000 at 6% interest p.a. In a year’s time, you will end up with Rs. 10,000 + Rs. 600 interest = Rs. 10,600 total. So, instead of withdrawing the interest, you re-invest it for another year at the same rate of interest. This would mean at the end of 2 years, you will have Rs. 11,236 (Rs. 10,600 + Rs. 636 interest).
The reinvested Rs. 600 gave you an earning of Rs. 36 without you having to do anything. This may seem like a tiny amount initially, but when re-invested over and over on a long term basis, it can accumulate a surprising amount of wealth for you. The funda is simple: It is not just the principal but also the interest that is earning interest for you.
Now, let’s have a look at a broader time frame for investment:
Let’s say you invest Rs. 10,000 today and park it into Treasury Bills earning 4% on an average for the next 50 years, you will end up having Rs. 71, 067 if purchases were made through tax-free account. Had you invested in stocks, earning 12% average rate of return as a result of riding out of fluctuations, you would have ended up with Rs. 28,90,022 at the end of 50 years. Adding asset classes giving higher returns would result in 40 times more money thanks to the power of compound interest.
The key to getting maximum benefit out of Compound Interest is to start early and invest for a long period. If you are patient, the magic of Compound Interest will amplify the growth of your investment over time.
As they say, the right time to start saving is now. The capital is not really important as long as you stay committed to a long term of vision. Leave the rest to the wonder of Compound Interest to work its magic on your savings!
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