How does Compounding Interest work???

How does compounding work? When you save Rs.100 and get an annual interest of 10%, you will have Rs.110 at the end of one year. If its a compounding interest rate, then next year you will get a 10% interest on Rs.110, which then makes it Rs.121. The next year, interest will be calculated on Rs.121 at 10%. In time, these savings could grow exponentially.

 

They say of trying to attain your ideal BMI(Body Mass Index), eat less, exercise more, well its no different when money is involved. A parallel universal truth with regard to money is spend less, save more for you to reach your ideal level of wealth. The earlier you start saving for your rainy day (read retirement) the more richer you will be when it finally arrives.

Be consistent with savings

In this context, you need not be a financial whiz in your attempt to make yourself financially secure for the future. You simply need to be consistent in saving a portion of your money and let it compound over time. The wonderful effect of compounding gathers up momentum over longer periods of time and becomes an avalanche of wealth you can accumulate over time.

How does compounding work?

When you save Rs.100 and get an annual interest of 10%, you will have Rs.110 at the end of one year. If its a compounding interest rate, then next year you will get a 10% interest on Rs.110, which then makes it Rs.121. The next year, interest will be calculated on Rs.121 at 10%. In time, these savings could grow exponentially.

The Rule of 72

There are certain number rules that have been evolved to figure out a quicker method for calculations, especially in finance. Rule 72, is one such quick method of calculating how much time it will take, for your investment to double. Let’s use the same example to figure out the time frame in which the original amount saved, doubles.

So, if you invest Rs.100 with compounding interest of 10% per annum, the rule of 72 gives 72/10 = 7.2 years as the approximate time frame required for the investment to become Rs.200. So, if you equate the same to a larger amount of Rs.1L in approximately 7 years, it would grow to 2L. Hence, if you are planning to retire 40 years from the time of investment, your investment will approximately snowball to about 6 times from its original value. That is the avalanche effect of compound interest for you.

So invest time, consistency, patience and savings to obtain a financially secure future, when you need it the most.

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