5 must-know facts about compound interest to grow your investments
What's the story
Compound interest is one of the most basic concepts in finance, and it can prove to be an absolute game-changer when it comes to growing your investments over time. Unlike simple interest, which is calculated only on the principal, compound interest accrues on both the principal and interest earned previously. This allows your investments to grow at an exponentially accelerating pace. Here are 5 must-know facts about compound interest for every investor.
Time factor
The power of time
The longer you leave your money invested, the more you benefit from compound interest. Even small amounts can grow substantially over time (thanks to compounding). For example, investing ₹10,000 at an annual compound interest rate of 5% will grow to approximately ₹16,288 in 10 years. Starting early allows your investments more time to grow exponentially.
Compounding frequency
Frequency matters
The frequency at which interest is compounded plays a critical role in the growth of your investments. Whether it's compounded annually, semi-annually, quarterly, monthly, or even daily, more frequent compounding periods lead to greater earnings. This is because each period of compounding adds additional amounts to the principal more quickly, enhancing the overall return on investment significantly over time.
Return rate
Rate of return impact
The rate at which your investment grows is a key component of compounding results. A higher rate of return means your investment portfolio grows faster. For instance, an investment with a 7% annual return will double in roughly every 10 years, thanks to the rule of 72—a quick way to estimate the time taken to double by dividing 72 by the annual return rate.
Re-investment plan
Re-investment strategy
Opting to reinvest earnings instead of withdrawing them heavily maximizes the benefits of compound interest. By keeping all your gains in your investment account to earn more over time, you greatly amplify the overall growth potential. This strategy is way more effective than taking out profits on a regular basis, as it utilizes the power of compounding to accelerate investment growth.
Inflation effect
Inflation consideration
Over time, inflation reduces the value of money, making it crucial for investors to account for its impact on their savings. Investors relying on compound interest should consider real returns, which are adjusted for inflation, to ensure their investments grow in real terms. When planning for retirement, education funds, or future expenses, it's essential to factor in rising costs of living to avoid losing value over time.