Here’s one of the most powerful image for the power of compounding:
1% increase every day for the next 365 days (just 1 year) translates into an increase of 3678% (compounded increase) and not just 365% (which is simple increase).
Similarly, 1% decrease every day for the same 365 days reduces the value by 97.4%!
If we could appreciate the “Magic of Compounding” we would understand the benefits of starting early and discipline!
Let us understand the power of compounding with the famous story of the Persian emperor who was so enchanted with a new ‘chess’ game that he wanted to fulfill any wish the inventor of the game had. This inventor, a mathematician, decided to ask for one seed of grain on the first square of the chessboard doubling the amounts on each of the following squares. The emperor, at first happy about such modesty, was soon to discover that the total yield of his entire empire would not be sufficient to fulfill the ‘modest’ wish.
Just try converting into money in any currency and you will realize the importance of compounding.
Start with Rs 1000 and by investing Rs 1000 every month compounded at 10% amounts works out to Rs 78171 after 5 years. In 10 years it more than doubles to Rs 202457. The figures at the end of 15, 20, 25, 30 40, 50 years are Rs 402621, 724986, 1244159, 2080292, 5595607, 1,47,13,428!!
It is one thing to know theoretically about the difference between simple and compounding interest. It’s another thing to see an example.
Option I: Age 25, Invest Rs 5000 p.m. till age 60
- Asset @ 10% growth is Rs 1.91 crore
Option II: Age 30, Invest Rs 5000 p.m. till age 60
- Asset @ 10% growth is Rs 1.13 crore lacs
Difference between the two options at age 60: Rs 78 lacs while the difference in the amount invested is only Rs 3 lacs
Does it tell something about the power of compounding? The goal of compound interest is to make your money work hard for you. The alternative, of course, is to work hard for your money. Which would you prefer?
The key step in using compound interest is to actually start saving. You don’t have to save a lot – just save what you can. Compound interest will do the rest of the work for you.
Compound interest is so fascinating that Albert Einstein referred to it as “magic” and called it “The most powerful force in the universe”.
How do you use the power of compounding with your own investments? Simple, start now and don’t stop!