How compound interest turns small savings into big wins
What's the story
Compound interest is often touted as a financial superpower, but most of us ignore its true potential.
Unlike simple interest, which only accrues on the principal amount, compound interest lets your money grow exponentially by earning interest on the initial principal and the interest accumulated over time.
This can greatly affect your savings and investments and is an integral part of any personal finance strategy.
Here's how it works.
Duration
The power of time
Time is essential to leverage the full potential of compound interest.
The longer you keep your money invested, the more it expands due to the effect of compounding.
For example, investing ₹10,000 at an annual rate of 5% would give you more over 30 years than over ten years, as every year builds on the growth from the previous year.
Starting early can make a world of difference in accomplishing long-term financial goals.
Frequency
Frequency of compounding
The frequency with which interest is compounded determines how much you earn over time.
Interest can be compounded annually, semi-annually, quarterly, or even monthly.
More frequent compounding means higher returns since every compounding period adds to the principal amount sooner.
For instance, if ₹5,000 is invested at an annual rate of 4% compounded monthly vs annually, it will grow faster with monthly compounding.
Preference
Impact on savings accounts
Compound interest increases the growth potential of savings accounts manifold compared to simple interest accounts.
By opting for accounts offering compound rather than simple interest rates, and knowing their terms, like minimum balance requirements, you can maximize returns on your savings.
All this without the hassle or risk of other investment options.
Potential
Investment growth potential
Investments grow a lot with compound interest, particularly when you reinvest dividends from stocks and bonds instead of cashing them out.
This way, you can stay invested in the markets, riding over short-term price fluctuations.
Staying patient through these periods guarantees long-term gains, which is a win-win for all concerned.