Compounding is the ability of an asset to generate returns which are then reinvested in order to generate their own returns, in short, it means generating returns from previous returns. The best way to reap the most benefit from your investments, you need to start saving now. Here the key to compounding is the snowball effect that happens when our earning generate more earning. The interest you receive is not only on your original investments but also on any interest, dividends and capital gains which accumulate. This helps your money grow faster and especially if you are looking to save a retirement corpus, compounding is the way to go.
The three factors which influence the rate at which your money compounds is the interest rate you earn on the investment. Especially if you are invested in stocks it would bring your total profit from capital gains and dividends. Time plays a second major factor when you keep your money invested for a longer period of time in an uninterrupted fashion the bigger your fortunes have a chance of growing and finally it is tax you pay on the interest you have received or accumulated on your investments.
Compounding is the first step towards wealth creation, especially when you buy a mutual fund, here compounding allows you to earn interest on your principal and the reinvested interest thereby helping you build a large corpus over time. As they say, you don’t have to be rich to create wealth, all you need is the magic of compounding and a disciplined approach towards investing.
Here is a calculation to help you better understand how you can accumulate wealth via the power of compounding.
Let’s assume Rita began investing around ₹5,000 each month in a mutual fund which gave her an average return of 12% when she was 25 years old, until her retirement, and at 60 she should have accumulated a corpus of ₹3,25,55,921.
Let’s say if Leena began investing the same amount of ₹5,000 each month in a mutual fund which gave an average return of 12% when she was 35 years old until her retirement, at 60 she should have ₹1,01,02,440.
So the difference between the two is the “power of compounding” and the way to take advantage of the power of compounding is saving early and investing wisely.