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There are only two ways you can grow your money – by working or by investing. Usually, you must indulge in a little bit of both, especially in the activity of investing. Why? Compounding that’s why.
Compounding interest enables you to have passive earnings on your investment, hence the term ‘Power of Compounding’.
Mostly, the banks and other financial institutions credit compound interest. Most of the investment plans starting from bank FDs to ULIPs offer a compounding rate of interest (ROIs).
Compounding is the act of reinvesting the earned interest on the money. Thus, the next interest will accrue on a higher amount of money. The more times you can repeat this compounding of interest, the higher the growth of your money will be.
The repetition of compounding is referred to as the power of compounding. Usually, the compounding interest calculations are complicated for manual estimates. Thus, you can use compounding interest calculators to estimate compound interest on your investments.
You can use the following formula to estimate the future value (FV) of an investment based on the compound interest concept:
Where,
(This is the power of compounding, which determines the growth)
It considers the current value of the asset, the annual interest rate, and the frequency of compounding (i.e., the number of compounding periods) per year, and the total number of years.
Power of compounding is based on the principal action of reinvesting your earnings from an investment in the same instrument. For example:
If you invest Rs 12 lakhs at an ROI of 5% p.a., for 20 years, your investment performance will look like the following:
| Particulars | Simple Interest | Compounding Interest |
|---|---|---|
| Investment amount (Rs) | 12 lakhs | 12 lakhs |
| Rate of Return | 5% p.a. | 5% p.a. |
| Investment Tenure | 20 years | 20 years |
| Compounding* Frequency | No compounding | Once a Year |
| Total Interest | 12 lakhs x 5% x 20 = 12,00,000 | 12 lakhs x (1 + 5%)^(20) = 19,83,957 |
| Future Value | 24,00,000 | 31,83,957 |
* Compounding ~ reinvesting
Thus, you can see that non-compounded (or reinvested) interest falls short of the compounded interest. In the compounding interest option, the annual interest has been reinvested at 5% p.a. ROI. Thus, generating interest on interest.
The higher the number of compounding, i.e., the value of ‘n’ in the formula, the better growth your money can enjoy at the same rate of return.
The power of compounding calculator makes your life easier with compounding interest calculations.
You can easily calculate compounding interest online using the freely available calculator tools. Using a compound interest calculator is easy as you only need to follow a few simple inputs and the answer arrives within a fraction of a second.
Compounding interest calculator requires the following inputs from you to give you a picture of the growth and future value of the investment:
This is the money you want to invest. This is also called the principal investment amount. This is a one-time investment and not a regular payment.
If you want to estimate the future value of a recurring payment (i.e., recurring deposits or SIPs) you will need to use the annuity calculator.
This is the time for which you will stay invested. Make sure to give that number for which you will leave the investment untouched. Withdrawing the investment even partially will alter the estimates.
Usually, this number is provided in years.
This is the yearly rate of return your investment will earn throughout the investment period. The rate of return as well, cannot change within the selected investment period.
If you expect the return to change in the middle of the period, you will need to estimate the final future value in two separate steps.
After selecting your inputs, the calculator automatically gives you the future value of your investment.
This calculator should help you arrive at an estimated value of your long-term investments.
Consider that you and your closest competitor are involved in the same trade. Both of you started at the same time with the same amount of money.
However, it takes you five days to clear your stock, while your competitor takes seven. You would’ve doubled your money in just about 20 days while your competitor will take 28 days to achieve the same wealth.
If you want to invest for a comfortable retirement, start early. Such saving and investment schemes are a great option when you start investing at an early age. Thus, you can also say that the more compounding you have within a given period, the higher your growth can be.
Here are 5 essential investment options for a comfortable retirement.
Different investments use different power of compounding. For example, bank fixed deposits are usually compounded quarterly. Interest in PPF and many post office schemes are compounded annually. However, in any case, the rate of interest is represented annually for every investment.
Two factors may play a role in defining the power of compounding for an investment:
1. Accounting principles2. Interest credit
For example, banks maintain their books quarterly, thus, all the interest is credited and reinvested on the fixed deposit money quarterly. However, corporates may declare dividends only once a year. Thus, the compounding on investments dependent on corporate stocks will have annual compounding.
Any saving plan offering a return on your invested money would try to give you a compounding rate of interest. Even if tentative, this is a reference quantity you can compare with other investment options and make a qualified decision.
The most popular compounding rate is the annual compounding rate. This rate of return is also referred to as Compounded Annual Growth Rate or CAGR. CAGR is an estimated compounded rate of return. Meaning, you converted your absolute returns from an investment into a number which you can draw parallels with similar other investments.
For example, if you have the following two investment results:
1. Bank FD giving 7.5% p.a. compounded quarterly on a 7-year deposit2. Mutual Fund investment returning Rs. 75 for every Rs. 100 invested 7 years ago.
You cannot compare both investments unless you bring them to a common ground, i.e., either convert FD return to an absolute value, or convert the mutual fund’s 75% in 7 years to an annual rate of return.
The power of compounding calculations is not as straightforward as other simple mathematics estimates. However, using the calculator you can have the following benefits:
1. Calculations Made EasyThe power of compounding calculator is simple to use. You can select the values for different parameters and the calculator will do the rest for you.
2. Helps Plan your Money & FutureIt helps if you know how much money you will need and when. Or have answers to the questions like, if I invest this much at this rate how much money I will have in a few years. If you are planning to invest in a savings plan, you must know how much money you will be getting at the end of the policy term.
Know if saving plans are a good investment choice for you.
3. Compare Different Investment OptionsYou can use the rate of return and other parameters from the investments you are considering and estimate the future values of your investment.
4. Create and Draw Conclusions from ScenariosThe power of compounding calculator is a very flexible and easy tool to work with. Thus, creating multiple investment scenarios and giving wings to your imagination is not a difficult task.
5. Improve your SavingsThe power of compounding calculator can really motivate you to save and invest more. When you see how a small amount of money invested for the right amount of time can turn into a huge sum, you are unlikely to ignore the temptation to save more.
6. Completely Free of CostThe best part of the calculator is, perhaps, the cost of using it. It virtually nothing, even time is a nominal investment when you are using it, as the calculations take only a fraction of a second to complete.
The power of compounding is a magical and the most beneficial aspect of any investment. If you understand the crux of it, you are bound to fall in love with investing.
The exponential growth offered by this concept has the potential to set you free from the need to work for money. The power of compounding should motivate you to improve your savings with the following steps:
Starting early is the foundation for extraordinary growth. Early investment will give you a higher growth benefit. The power of compounding works better as your investment period increases.
Since the timeline for your financial goals is pretty much static, investing early is the only way to increase the number of compounding for your money.
The earlier you invest the more time you will have to grow your money before you have to withdraw.
You may already be wondering, early investment means investing a very small amount. So, is it valuable enough? Of course, it is.
First, your small investment made a few years back can beat the bigger investments made later.
Second, if you can manage your expenses well, you can even increase this small amount. Thus, after early investment, spending control becomes the most important task for making the most of the power of compounding.
One way to achieve this is by budgeting. You can control, limit or postpone unimportant expenses from your budget. Remember, that every penny saved now, will become a source of future income.
Saving money is not enough. Your journey to compounding interest will only start once you invest it somewhere. Your choice of investment will depend on the three factors:
While you take care of these three, another aspect that matters is tax. However, all you need to do is to use a tax-saving investment wherever possible. For ultra-short-term investments playing safe is the best option.
One warning sign you must be mindful of is going after higher returns. Remember, risk and return are sisters who always travel together. While you can manage risk to some extent, return is always unpredictable.
Compounding relies on the idea of reinvesting the earned interest. Thus, for maximum benefit, the maximum part of the interest should be reinvested. This is possible, so far as you do not withdraw anything from the investment
Hence, to achieve your life goals, give some undisturbed time to your investment.
Your income is regular, and so should be your investments. Regular, disciplined investments provide you with an edge with compounding interests. Thus:
Such discipline will help you maximise your benefits from the power of compounding. Don’t believe in these words? Use the compounding interest calculator to see for yourself.
ULIP are a perfect blend of goal-oriented investment plans with protection options. ULIPs also offer market-linked returns, rather than a fixed defined return. ULIP allocate your money to different funds, which will invest in market securities to generate returns.
A majority of these funds rebalance or reinvest the earnings quarterly. Thus, you can assume that your money will be compounded quarterly or four times a year in the ULIP.
ULIP offer multiple ways for you to use the power of compounding on your investment:
You can invest monthly, quarterly or annually in ULIP. The best way to invest in ULIP is to match the investment frequency with your income and use auto-debit.
ULIP allow long-term investing. The investment tenure in ULIP can range from 5 years to until you reach 99 years of age
ULIPs like Invest 4G from Canara HSBC Oriental Bank of Commerce Life Insurance, offer bonus additions to long-term investors. These bonuses add to the compounded growth of your portfolio.
When you invest in equity market funds, managing your risk is important for generating returns. ULIP allow you to manage your risk even when not active. Portfolio management strategies in ULIPs will automatically manage your risky portfolio as per market performance.
Time is even more important than the amount of your investment. Even if you start small, staying invested long enough will easily put you ahead of larger short-term investors.
Consider the following example, where two friends who have an identical financial situation, end up with completely different financial results:
If both will earn a rate of interest of 8% p.a., who do you think should have more money at the age of 60?
(Use the calculator to find out)
Understand how saving at an early age of life will help you during retirement.
| When Compounding is Annual | When Compounding is Quarterly | |
| Growth of Rs 100 in 7 years at 7.5% p.a. rate of interest | 165.90 | 168.23 |
Power of compounding refers to the number of times the interest earned on an investment is reinvested at the same rate of return. It is the factor that determines the number of times the interest multiplies in the investment.
In a philosophical sense, the power of compounding also means the quality of compounding returns to provide exponential growth to your investments.
Purchasing power determines the value of any amount of money at a given time. For example, you can buy 5 grams of 24 karat gold for Rs. 25,000 now, but in five years you will only get about 4.5 grams. That is because of the rise in the gold price.
The general rise in the price of daily use commodities is called inflation. This inflation causes the value of money to decline gradually. Usually, the rate of inflation is indicated as an annual percentage. For example, the inflation rate in India for the year 2020 was 6.2%.
Meaning the purchasing power of Rs 100 you had in your pocket at the beginning of the year diminished by Rs 6.2 by the end of the year.
So, if the average annual inflation rate is 5% p.a. Rs. 25,000 will be worth Rs. 9422 in 20 years.
When you invest money, your money grows by the rate of return provided by the investment instruments. For example, when you invest in a bank FD, you receive the interest as provided by the FD for the selected tenure. Say, a 5-year FD offers a 7.5% p.a. quarterly compounded rate of interest on deposits.
Thus, the power of compounding in this FD will be 5, for the annual return and 4 within a year due to quarterly reinvested returns.
In total, the power of compounding will be 20, i.e., invested money will with compounded 20 times in five years.
Compounding power reflects the reinvestment of interest. Thus, you can use the power of compounding to estimate the interest factor for the investment period. For example, the rate of return on an investment is 7% p.a. If you invest money in this investment option for 10 years, your interest factor would be “1.07^(10)” or 1.967.
This means every Re 1 invested in this option will grow to Rs 1.967 in 10 years.
Simply invest the money in instruments that offer a rate of return higher than inflation to meet your investment goals. This will ensure the real growth of your wealth in terms of purchasing power. Meaning your wealth will enable you to buy more assets in the future.
Once your invested money is generating annual returns which are higher than your cost of living in absolute terms, you have a unique situation where your wealth starts to compound. For example, if your investments generate Rs. 10 lakhs in a year while you only spend Rs. 5 lakhs, the remaining Rs 5 lakhs will be reinvested.
The reinvested money will increase your return on investment for the next year, officially increasing your wealth without additional investment from you.
If you look at running business stocks will compound only when earnings are declared and a part of it is reinvested in the company’s growth. Which may happen quarterly or annually. So far companies review their books and estimate earnings only quarterly, thus the stocks can be said to compound quarterly.
Compound interest has no disadvantages except in the following two scenarios:
In the first case, the estimation of the change at a compounded rate is difficult for manual calculation, because you will need to use complex estimates.
In the case of a negative interest rate, you end up losing money after investment, and since the rate is compounded, the loss is exponential.
Anytime, compound interest means that even your interest starts earning interest after a period. Simple interest on the other hand only accumulates interest but the underlying investment remains the same.
Thus, no matter how long you stay invested, your return on investment will remain the same at a simple rate of interest. However, with compounded interest, your return in the next period will be higher than the previous ones.
Compound interest is considered a powerful concept because you only need to initiate your investment and the rest happens automatically. Imagine your business running itself without your intervention and even start growing itself.
Compound interest can ensure that after crossing a threshold your wealth continues to grow even without additional investment from you. Financial planners call this the stage of financial freedom.
Your money starts generating money for you at this stage. So, you do not really need to work for money anymore.
The most benefit goes to the investors. However, almost every link in the value chain benefits from compound interest. For example, understand that compounding occurs when business income is reinvested into the business for growth.
Thus, compounding helps the business expand its footprint, serve more customers, employ more workers, and grow the value of investors’ money.
Different investment instruments compound the earnings with different timelines. Similarly, these investments will have a different impact on the growth of your investments due to the power of compounding. The most common ways of compounding the interest are as given below:
Other hypothetical compounding scenarios, like the ones given below, can also be presented:
You can use the compound interest calculator to estimate the impact of different modes of compounding on your investment.
More compounding means more power of compounding and yields higher effective returns. The more frequent is the compounding, the higher is the effective return from compounded interest
Hence, if you have to calculate compound interest daily compounding will yield better growth than monthly compounding.
Simple interest means the interest calculated on the total principal amount. Whereas compound interest also includes the previously accrued interest on the principal amount and accumulated interest.
Compounding interest is the interest on interest. Thus, if you are to calculate compounding interest you may need to use a compounding calculator for accurate results.
Compounding interest means the interest on interest and offers multiple benefits over simple interest. Here are the key advantages of compounding interest:
You will need a compounding interest calculator to estimate the future value of an investment with compounding interest.
A compounding calculator will clearly show you that investing the same amount of money at a similar rate will yield higher returns as compounding frequency increases
Daily compounding could be the highest frequency of reinvestment you can achieve with manual intervention.
Terms & Conditions
This calculation is generated on the basis of the information provided and is for assistance only. And is not intended to be and must not alone be taken as the basis for an investment decisionThe calculations mentioned above take into consideration an assumed rate of inflation of 8%. #The current costs of education mentioned above are approximate values. The end value displayed is on the basis of the information provided and is for assistance only. It is not intended to be and must not alone be taken as the basis for an investment decision. *A 30 years old healthy male can start the plan with a premium payment of Rs. 4000 per month with a policy term of 15 years. The total assumed benefit @ 8% would be Rs 11.43 Lakhs and at an assumed rate of return of 4% p.a., the total benefits would be Rs 8.33 Lakhs. Values are illustrative and actual benefit may depend on number of factors, including future investment performance. Advt No. W/II/1187/2015-16.This calculation is generated on the basis of the information provided and is for assistance only. And is not intended to be and must not alone be taken as the basis for an investment decisionThe calculations mentioned above take into consideration an assumed rate of inflation of 8%. #The current costs of education mentioned above are approximate values. The end value displayed is on the basis of the information provided and is for assistance only. It is not intended to be and must not alone be taken as the basis for an investment decision. *A 30 years old healthy male can start the plan with a premium payment of Rs. 4000 per month with a policy term of 15 years. The total assumed benefit @ 8% would be Rs 11.43 Lakhs and at an assumed rate of return of 4% p.a., the total benefits would be Rs 8.33 Lakhs. Values are illustrative and actual benefit may depend on number of factors, including future investment performance. Advt No. W/II/1187/2015-16.
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