Power of Compounding

Introductio
n
One of the most basic premises of investing is that your
money multiplies manifold over time and this
multiplication of money is normally referred to as the
"Power of Compounding". The compounding effect of
investing your money is perhaps one of the most
important aspects to achieving long-term wealth. For it
to work, you must be a long-term investor with lots of
patience.

When you invest money, it earns interest (or returns). If

you keep the interest invested, then it does not sit idle
while only the original investment sweats it out. The
interest earns interest too and then the interest on the
interest earns interest again.
This is the beauty of compounding. That is what made
great men like Warren Buffet extol the virtues of
"compounding".

What Does Compounding

Mean To An Investor
Let us understand this with the help of an example. Mr.
A, Mr. B and Mr. C are three friends with same
background and age:
On his tenth birthday, Ms A's father gave him Rs. 100.
He wisely invested the money that earned him an
interest
of
15%
every
year.
Mr. B won Rs. 200 as prize money when he was 16 years
old. His friend, Mr. A, advised him to invest his prize
similarly. When Mr. C earned his first salary at the age
of 21, he salted away Rs. 400 in the same instrument as
Mr.
A's.
After reaching the age of 60, all three decided to

You will tend to think its Mr. C, right? After all, he

invested four times the sum that Mr. A had invested.
So what if he had invested the money ten years later?
He did earn interest for 40 years after that. But think
again. Mr. A made the most out of his investment, in
fact, his Rs100 was worth Rs108,366. On the other
hand, Mr. C Rs400 was worth only Rs93,169.
It simply means that the longer you stay invested the
more money you will make.
Now you know why Mr. A made more money than Mr. B
and Mr. C.

Let us try one more example to understand the

impact of interest rates.
Let us assume Mr. A, Mr. B and Mr. C invested Rs100
for ten years. However, all three of them earn
interest at different rates. Mr. A earns 20% while Mr.
B earns 15% and Mr. C manages a 10% interest rate.
What is the amount each one of them will have ten
years hence?
Mr. A will have Rs619 while Mr. B will have Rs405.
while Mr. C will have the least Rs259 in ten years.
Have you noticed something though? While the
interest rates differ by just 5%, in ten years the
worth of the original capital, Rs100 would be vastly
different.
That is another way of understanding the power of
compounding or the power to grow exponentially.

The Rule of 72
The rule of 72 is an easy way to find out in how many
years your money will double at a given interest rate.
It is very simple, divide the number in the title by the
interest percentage per period to get the approximate
number of period needed for doubling.
Suppose the interest rate is 15%, then your money
will double in 72/15= 4.8 years. In case, the interest
rate is 20%, then the money will double in 3.6 years.
Thus the moral of the story is the longer you stay
invested the more money you will make.

The power of compounding when applied to the stock

market can make you rich many times over and sooner
than you can imagine. That is because historically, the
stock market is known to give the highest return per
annum over long term compared with the other
investment
instruments.
So, if you don't have an exposure to the stock market
yet, start right now as according to the power of
compounding, the longer you stay invested the more
money you will make.

Thank You!
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