Compound interest is one of the most powerful concepts in finance. It’s also one of the most misunderstood topics. If you’re not familiar with this concept, then you must read this article.
We will explain exactly what compounding is and why it plays such a crucial role in your financial future. Keep reading to learn more about how interest compounds, how much time it takes, and why you should care about it if you have plans to grow your money over time.
What is Compound Interest?
Simply put, interest is the earnings you earn on your investment. But compound interest is the process by which this interest is continually added to the principal, resulting in even greater earnings.
The compounding of money is one of the most fundamental concepts in finance, and it can help your savings grow exponentially.
If you put Rs. 100 into a savings account that pays 5% interest, then your Rs. 100 will become Rs. 105 in 12 months. Then it will become Rs. 118 in another 12 months. Then, Rs. 157.89 in the next 12 months. So on. What you are seeing is the growth of Rs. 100 over time due to compound interest.
How Does Compound Interest Work?
So if you deposit Rs. 100 in a bank at 5% interest, then you would make Rs. 105 in the first year.
At the end of the first year, you would add Rs. 105 to your account with another Rs. 105, resulting in a total of Rs. 210. But that Rs. 210 would then be earning interest too – Rs. 35.56 just in interest alone, which would be added to the Rs. 210 in the second year, resulting in a final amount of Rs. 245.56 at the end of the second year. You would have lost nothing by putting your Rs. 100 into the account at the beginning of the year, but you would have Rs. 245.56 at the end of the year.
Summing up: Is compounding important for your savings goals?
There is no harm in putting small amounts of money into a savings account and earning a bit of interest. But the power of compounding is what makes it worth the effort to aim for larger, longer-term goals.
It can help you save for a down payment on a house, your children’s education, or retirement. The key is to make sure that you stay invested for the long term. This can ensure that the interest generated on that money will compound into a large sum of money.
Although compound interest is a confusing concept to many, it is an essential part of financial planning.
Compounding does not happen overnight. It is a process that takes time. This process of compounding interest is what helps you achieve your financial goals. If you want to retire early, then you need to start saving now. Because you never know when it will be too late. You can also use a compound interest calculator to understand how compounding can help you grow your money.