How compound interest helps build wealth over time
What's the story
Compound interest is a powerful financial concept that can tremendously affect your savings, investments over time.
Unlike simple interest, which is calculated only on the principal amount, compound interest accumulates on the initial principal and the interest accumulated from previous periods.
This means your money grows at an accelerating rate, making it a vital tool for building wealth.
Here's how it works.
Growth potential
Know the power of compounding
The real beauty of compound interest is that it grows your wealth exponentially over time.
By reinvesting the interest you earn into the principal, you let your investment earn more returns in the coming periods.
For instance, if you invest ₹1,00,000 at an annual interest rate of 5%, compounded annually, you would have around ₹1,62,889 after 10 years. See how your amount grows with time!
Early start
Time is your best ally
Starting early is the key to maximizing the benefits of compound interest.
The longer your money stays invested/saved with compounding returns, the higher its growth potential.
For example, if you start investing ₹500 per month at age 25 with a 7% annual return, you could accumulate over ₹13 lakh by age 65, thanks to the power of compounding.
Compounding periods
Frequency matters
The frequency at which interest compounds plays a significant role in determining overall returns.
More frequent compounding periods result in higher total returns because each period adds more accrued earnings back into the principal balance sooner rather than later.
Common compounding frequencies include annually (once per year), semi-annually (twice per year), quarterly (four times per year), or monthly (12 times per year).
Real returns
Inflation considerations
While compound interest multiplies wealth exponentially, don't forget to account for inflation when calculating actual returns on investments.
Inflation reduces purchasing power, making it necessary to take timely action in the market.
This is more relevant today than ever before due to the changing economic climate globally and domestically.
Without taking timely steps according to current market trends, inflation can adversely affect long-term financial returns.