Compounding : Why it is most improtant in investing ?


“Compound interest is the eighth wonder of the world. He who understands it earns it… he who doesn’t… pays it.”
                                 – Albert Einstein.

Compounding plays a very important role in long term investments all the successful investors like Warren Buffet, Carlos Slim, Rakesh Jhunjhunwala, Radhakrishan Damani are taking advantage of compounding.

Compound interest– Compound interest is the interest you earn on interest.

For example – You invested Rs.100 with 10% annual returns then after one year your Rs.100 becomes Rs. 110 and again after one year the return will be 10% from Rs,100 (initial investment) + 10% from Rs.10 (interest) which means you Rs 100 will become Rs 121 after 2 years. If you invested your money for a long time then this value will become very large.

In Compounding, we take the help of the “Reverse CAGR calculator” to find the future value of our investment with compounding.

CAGR – Compounded Annual Growth Return.”

Just simply Type Reverse CAGR calculator on google and you will get too many websites of Reverse CAGR calculator.

Now, we are going to see the example of compounding.

To calculate the future value you have to fill their things like starting value (initial investment value), CAGR (annually return percentage) and time (how long your investment will be).

So, let say you invest Rs.1,00,000 as an initial investment with a 15% annual return percentage (CAGR) for 1 year.

The future value after one year will be Rs.115000 as you can see in the image below.


Now, let see the value of your investment after 2 years, the value becomes Rs. 132250. After two years as shown in the image below.


Explanation of Compounding

1 year = 100000 (initial investment) + 15000 (15% return) = Rs.115000.

2 year = 100000 (initial investment) + 15000 (return of 1st year) + 15000 (15% return on initial investment) + 2250 (return on interest) = Rs.132250.

And also for 3 years =
100000 (initial investment)
+ 15000 (return of 1st year)
+15000 (return of 2nd year)
+2250 (return on the interest of the first year)
+15000 (return on initial investment)
+2250 (return on the interest of 1st year again)
+2250 (return on interest off 2nd year)
+337 (return on the interest of 1st year)
Total = Rs.152087

Isn’t it crazy?

After 28 years the value of your Rs.100000 will become Rs.5000000 and after 33 years the value of your Rs.100000 will become Rs.10,000,000.

As you can see your investment takes 28 years to become 50 lakh and 33 years to become 1 crore. So, in this example, you can see the power of compounding in 5 years after 28 years. Compounding is the eighth wonder of the world.

If you have any queries related to this please feel free to conduct us.

  • Thanks for reading.

Previous Chapter

CLICK HERE

 

+ There are no comments

Add yours