Compounding is the process of the exponential increase in the value of an investment due to earning interest on both principal and accumulated interest.
We want a change NOW !
We live in an environment where we want :
All this instant gratification makes one believe that one deserves things / results right NOW, without working for them.
But if one continues to believe this thought then be prepared for severe disappointment.
What it really takes is that one small consistent step over and over again coupled with self belief to start the journey and achieve milestones.
A new runner should be able to run a half marathon in a span of 6 months of consistent training and discipline effort:
By the end of 25 weeks one should be able to run the entire half marathon much faster than you thought was possible, just believe in yourself.
So what habit we get out of all of this just walk/jog every day, whatever your fitness level is just do small actions every day all of this is display of COMPOUND effect.
When investing, there are two broad classifications of interest : Simple & Compounding
Simple interest is calculated on the original or principal amount of an investment.
Compound interest is calculated on the principal amount and also on the accumulated interest of previous periods, and can thus be defined as “Interest on Interest”.
Compounding is a simple & powerful concept when implemented for creating long term wealth.
Let’s see how they work.
Suppose Mr. Kumar & Mr. Kaushal invest Rs. 1,00,000 in two different accounts. One carrying simple interest and other compound interest.
The interest rate for both the accounts is 8% and is deposited for 25 years bucket.
Mr Kumar invested in simple interest account. He withdrew Rs.8,000 as interest every year for the next 25 years and left principal Rs. 1,00,000 back. After 25 years Mr. Kumar would have withdrawn Rs. 2,00,000 as interest and capital of Rs. 1,00,000.
Mr. Kaushal didn’t withdraw interest, but left both capital and interest invested for next 25 years. After 25 years Mr. Kaushal would have accumulated Rs. 5,84,000 as interest in addition to principal amount of Rs.1,00,000.
Refer below graph, Mr. Kumar’s investment grew in a straight arithmetic line whereas Mr. Kaushal’s investment grew geometrically; rapid and ever increasing.
The key is maximizing power of compounding, the snowball effect that happens when your earnings lead to long term wealth creation.
Compounding is an extremely powerful tool, especially if one can harness it over time.
That means realising that the EARLIER one starts to invest and the MORE you have to invest will unravel benefits of compounding.
Content : Ajit Kaushal