Compounding is defined mathematically as “the rise in the value of an investment as a result of interest earned on the principal as well as accumulated interest.”
Explained, it is a method of putting your money to work for you. It has the potential to be a tremendous tool for increasing your wealth. Compounding can help you plan for your future goals, like retirement.

The term “simple interest” refers to the fact that you earn interest on your principal. On the other hand, compound interest pays interest on both the principal and the accrued interest amount over time. This interest accumulates to a significant sum over time.

Here’s an example to demonstrate the power of compounding.

Vijay and Geeta each put in Rs 50,000 in an investment that pays a 10% yearly interest rate for ten years. Vijay prefers simple interest, while Geeta prefers compound interest (read re-invest).

Vijay would have a total corpus of Rs. 1 lakh at the end of ten years. Geeta, on the other side, would be paid Rs. 1.30 lakh.

Because the interest was calculated just on the original principal amount of Rs. 50,000 in Vijay’s case, this is the situation. In Geeta’s instance, however, the interest generated each year was added to the principal to compute the following year’s appeal. This aided her in increasing her earnings.

Compounding has a lot of advantages.

The value of time is one of the essential advantages that investors may gain from compounding. You could earn returns over time, and the yields on these returns may generate more returns, allowing you to expand your investments quickly.

It’s a good idea to save money and collect compound interest every year. But what if you invested a set amount every month? This modest gesture could help you earn more money in the long run. Let us investigate how this is feasible.

Your gains may accumulate at a considerably faster rate if you frequently invest over time.

Mutual funds and the power of compounding

We’ve discussed the advantages of investing a set amount regularly to take advantage of compound interest. However, there is a significant issue to be solved. Where should an investor put their money to get the most out of compounding?

Mutual funds are the answer.

Mutual funds are meant to enhance the benefits of compounding as an investment option. Systematic Investment Plans make this achievable (SIPs).

The following is how it works: A Systematic Investment Plan allows you to regularly invest a set amount in mutual funds (SIP). This could be done on a monthly, quarterly, or semi-annual basis. You can choose a fund, calculate the return on your investment using a SIP calculator, and make a SIP payment on the due date. Regularly investing through SIPs can help you increase your returns over time.

While most fund types are available through a SIP, you may want to choose equity funds for long-term goals such as retirement planning. This is because equities funds have the potential to provide higher long-term returns.

The most fantastic thing about SIPs is that they allow you to automate your payments by sending your bank a standing instruction. You can transfer money straight from your registered bank account to the mutual fund on the chosen day. As a result, you won’t have to be concerned about missing payment deadlines.

Key rules to enable the power of compounding

  • Control your expenses
  • Start early
  • Be disciplined
  • Learn patience