Power Of Compounding: What Is It And Why Does It Matter?
Compounding is a powerful financial tool, and it makes your savings grow exponentially over time. It helps in increasing your income potential effortlessly. Compounding simply means reinvesting your investment earnings on an annual basis rather than spending them right away.
Let us explore the power of compounding and how it can help you achieve your financial goals, such as saving more money for higher education, the marriage of children, or retirement.
How Compounding Helps You Grow Wealth
Compounding is one of the greatest wealth-creating forces. It makes your money not only grow by earning interest but also by earning interest on interest earned. The earlier you begin, the more you will benefit. More significantly, you must allow your returns to compound rather than take them out.
For instance, if you put INR 1,00,000 annually in a compounding investment vehicle with 8% returns and allow your gains to accumulate, for a total of INR 5,00,00 investment for 5 years, your initial amount will accumulate to INR 6.3 Lakh. Have a look at this table to understand this better:
| Year | Opening Balance (in INR) | Investment (in INR) | Compound Interest (in INR) | Closing Balance (in INR) |
| 1st | 0 | 100000 | 8000 | 108000 |
| 2nd | 108000 | 100000 | 16640 | 224640 |
| 3rd | 224640 | 100000 | 25971 | 350611 |
| 4th | 350611 | 100000 | 36049 | 486660 |
| 5th | 486660 | 100000 | 46933 | 633593 |
How Opting For Compounding Is Wiser?
When you invest, you can earn interest in two ways. One is simple interest that generates regular returns and the other is compound interest, which improves your returns manifolds.
Let’s deep dive into the concept by comparing both types of investments.
Simple Interest vs Compound Interest
Simple interest gives you interest on the original principal amount only. So, though your money will increase, you would not be getting interest on interest. In compound interest, each year the principal amount will be revised since the interest will be added to the investment.
So, basically, you will begin to accumulate more interest over the years because of this compounding. The secret to amassing wealth through compound interest plans is to keep on remaining invested for a longer duration.
For instance, assume that you invest a lump sum of INR 1,00,000 in a simple interest plan and a compound interest plan at an interest rate of 8% per annum. This is how your money will grow:
| Year | Simple Interest (INR) | Total with SI (INR) | Compound Interest (INR) | Total with CI (INR) |
| 1 | 8,000 | 1,08,000 | 8,000 | 1,08,000 |
| 5 | 40,000 | 1,40,000 | 46,933 | 1,46,933 |
| 10 | 80,000 | 1,80,000 | 1,15,892 | 2,15,892 |
| 15 | 1,20,000 | 2,20,000 | 2,17,217 | 3,17,217 |
| 20 | 1,60,000 | 2,60,000 | 3,66,096 | 4,66,096 |
It is evident that after 20 years, the simple interest investment returns are much lower than for the compound interest returns. This shows the power of compounding over the years with no additional investment on the same lump sum investment.
Key Factors That Influence Compounding Returns
To benefit from the magic of compounding, an investor must understand the following crucial factors:
1. Time: The longer your money is invested, the more compounding cycles it goes through. This enables gains to create more gains. Beginning even a few years earlier can result in much greater returns.
For instance, a 25-year-old investing for 35 years can end up with more money than someone who begins at 35, even if the latter invests more money in total.
2. Rate of Return: Faster returns lead to faster compounding. A 2% difference in return every year can create lakhs of rupees in additional wealth over 20–30 years. Opting for investment schemes with historically superior long-term returns, like equity mutual funds, can dramatically enhance outcomes.
3. Frequency of Compounding: The more frequently your returns are compounded, the quicker your investment accumulates. Compounding daily or monthly involves more often adding earned interest to the base, which is compounded more often. In the long run, this generates significantly more accumulated wealth than compounding once a year.
4. Consistency: Being disciplined with regular investments causes your investment to continuously grow without any gap. Missing contributions or taking premature withdrawals diminish the base value, diluting future growth. Having automatic monthly investments (SIPs) maintains consistency and optimises compounding benefits.
Real-Life Examples Of Compounding Returns
Let us consider the example of Aman and Rahul, both aged 35 in 2025 and set to retire at 60 in the year 2050. Aman started his investment journey early, beginning to invest in mutual funds and other long-term investment options back in 2015 when he was just 25.
In contrast, Rahul delayed his financial planning and only began investing at the age of 35.
Example 1 – Starting Early, Stopping Early
Aman begins investing INR 5,000 every month at age 25. He invests for just 10 years and ceases at age 35. His investment is INR 6,00,000. He does not withdraw the money and lets it grow till age 60. With an 8% return every year, his corpus reaches around INR 67.59 lakh by the time he retires.
Example 2 – Starting Late, Investing Longer
Rahul starts investing INR 5,000 a month at the age of 35. He keeps investing till he is 60 years old, for a total of 25 years. He invests a total of INR 15,00,000 — nearly double that of Aman's.
Even with the increased investment, his maturity corpus is around INR 47.87 lakh, given the same 8% return per annum.
Why Aman Earned More with Less?
Time is what counts. Aman's investment had 25 more years to compound. He contributed for 10 years, yet allowed his money to compound for 25 years altogether. His head start provided additional compounding periods, even without additional contributions. Rahul contributed for a longer period of time and made larger contributions, but the late start provided his money with fewer years to increase.
The compounding power comes from the fact that if you start early, though your total investment will be less, you can build more wealth, simply by allowing your money to grow for a longer period of time.
How To Maximise The Power Of Compounding
Compounded interest beats simple interest. These are some tips on how to get the maximum out of your compound investments:
1. Start Early, Even with Small Amounts
Time is your best friend. Starting early gives your funds more time to grow in the long run as a result of compounding. Even small amounts can make a huge difference over a period of decades.
2. Be Regular with Contribution
Monthly SIPs or regular investments, regardless of market conditions, help build a strong financial foundation. Consistent contributions through SIPs ensure that you continuously benefit from the power of compounding, steadily growing your wealth over time.
3. Reinvest Dividends
Rather than withdrawing interest or dividends, reinvest them. This speeds up growth by enabling your returns to earn their own returns, maximizing the compounding effect.
4. Select Investments With Beneficial Compounding Frequency
Select investment vehicles that compound interest more often, like quarterly or monthly. More frequent compounding periods can result in greater overall returns over time.
5. Reduce Withdrawals and Avoid Disruptions
Let your investments build up uninterrupted. Steady withdrawals will interfere with the process of compounding and reduce potential gains. Long-term perspective and patience are important.
6. Keep an Eye on and Realign Your Portfolio
Review your investment portfolio periodically to verify that it is in keeping with your financial objectives. Rebalancing and reformulating asset positions can preserve optimum growth and risk levels.
FAQs On Power Of Compounding
1. What is the power of compounding in simple words?
Compounding helps your money grow by earning interest on both your savings and the interest already earned. Over time, this snowballs into much bigger returns. Starting early gives compounding more time to work in your favour.
2. Is compounding interest better than simple interest?
Yes, because it invests your income to grow even more. Simple interest grows only on your original sum, which has restrictions on the return. With compound interest, time and persistence create wealth without more effort.
3. How many years does it take compounding to double money?
Use the Rule of 72; just divide 72 by your return rate. At 8%, it takes roughly 9 years to double. The higher the rate, the quicker your money grows.
4. Is it better to compound daily or monthly?
Daily compounding earns slightly more than monthly, as interest is added more often. Even small differences in frequency add up over time. If possible, choose investments with more frequent compounding.
Want to stay at the top of your finances?
Join the community of 4 lakh+ investors and learn more about Grip Invest, the latest financial knick-knacks, and shenanigans in the world of investing.
Happy Investing!
Disclaimer - Investments in debt securities/municipal debt securities/securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully. The investor is requested to take into consideration all the risk factors before the commencement of trading.
This communication is prepared by Grip Broking Private Limited (bearing SEBI Registration No. INZ000312836 and NSE ID 90319) and/or its affiliate/ group company(ies) (together referred to as “Grip”) and the contents of this disclaimer are applicable to this document and any and all written or oral communication(s) made by Grip or its directors, employees, associates, representatives and agents. This communication does not constitute advice relating to investing or otherwise dealing in securities and is not an offer or solicitation for the purchase or sale of any securities. Grip does not guarantee or assure any return on investments and accepts no liability for consequences of any actions taken based on the information provided. For more details, please visit www.gripinvest.in
Registered Address - 106, II F, New Asiatic Building, H Block, Connaught Place, New Delhi 110001
