Power of compounding can be experienced, when your earnings start generating more earnings. You receive interest not only on your original investments, but also on any interest and dividends that accumulate. This way, your money can grow faster and faster, as years go by.
Let’s take an example:
Let’s say you have 2 separate accounts having Rs 1 Lac. Each account earns 8% every year. In first account, you withdraw your investment earnings each year and the value of the account stays steady (Red Line in chart). In other account, you don’t cash out your interest earnings, i.e. they get reinvested. The curved green line shows the power of compounding and time. If you keep reinvesting the interests, after 40 years, your investment will have grown to more than Rs 20 Lacs.
In this way, it would be your money working for you rather than you working for money. And this will make a huge difference to your future account balance.
Note – This is a hypothetical example, and actual returns would be different, depending on change in interest rates and other factors.
Additional Note – If you are amazed by this concept of money working for you (wow!), then you might also like to read about the power of doing nothing in stock markets and story of an Indian multibagger.
Related Reading: How to Live off Dividend Income in India?
Hi..
Compounding works on Two basic principles : (1). Reinvestment of earnings and (2). Period of investment….
Jigisha Shah
@9b84db4bd6510767229d490fb928d1d0:disqus
True. And longer the period of investment, better it is. 🙂
In the figure above, in red box the amount should be 1 lakh not ten thousand.