Albert Einstein, the renowned scientist had said...
Compound interest is the eighth wonder of the world. He who understands it, earns it... he who doesn't... pays it.
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Luckily for us, we do not need the intelligence of Albert Einstein to understand the power of compound interest! This simple concept is taught in high school.
How it works...
- Imagine you invest ₹ 10,000 for 10 years. The rate of interest is 10% per year
- At the end of Year 1, you will earn ₹ 1,000/-. Thus your invested amount will grow to ₹ 11,000/-
- At the end of Year 2, you will earn ₹ 1,100/-... and so on.
- Finally, at the end of year 10, you will earn ₹ 2,358/- for that year, while the initial sum of ₹ 10,000 will grow to around 25,940.
* Each year's interest is added to next year's principal amount and reinvested @ 10% p.a.
This chart is for illustation purpose only.
Basically it means that when you invest for long periods of time, you start earning interest on interest.
On the other hand, if you were earning simple interest, you would have only earned a flat sum of ₹ 1,000/- per year for 10 years and the total amount would have only grown to ₹ 20,000/-.
The difference of ₹ 5,940/- is because you have earned interest on interest.
In a nutshell, compound interest is the magic of earning interest on interest.
Amazing, isn’t it?
An example
Here is an example of how compound interest can convert small savings into large numbers:
Just imagine this: You are a young 20 year old 'branded' coffee lover.
Now, assume one day you opted to drink the neighbourhood Udipi restaurant coffee, costing ₹ 25/- over the fancy one, costing ₹ 125/-
Further, you invested this difference of ₹ 100 at 15% per year for the next 40 years. Can you estimate how much you would accumulate?
₹ 26,786!
Still desire that fancy coffee?
There is a simple sure-shot formula to get rich. Start saving and investing early, compound regularly at reasonabe rate of return.