Understand the Power of Compounding Interest
“The most powerful force in the universe is compound interest” – Albert Einstein.
Compounding interest is, interest paid on interest, resulting in a higher interest income on the initial investment.
While investing, you always have to be aware about the cost of investing. You might have your capital and borrowed capital is suggested to invest in stock markets, still you should calculate the return from other sources if money is not invested in stock market.
100 bucks Return @8% Comparison
Recent bank deposit interest is 7% p.a. in India. You can get upto 10% safe return on your capital for the longer investment. When you invest in stock markets or mutual funds your risk of losing money are also there. So, the expected return on risky investments should be around 20%.
If you calculate the Simple Interest on Rs. 100 @ 8% per annum for thirty years, it will be Rs. 240 plus 100 as capital will be Rs. 340. And compounding yearly, interest for the same will be Rs. 906. So, total capital will be Rs.1006. Additional Rs.666 more can be earn by simply changing the method of calculating the interest.
The above example looks very small benefit of Rs.666, but it is not. As it has been calculated on Rs.100 only for better understanding. To achieve the same goal of compounding interest, investor would need to have simple interest rate of 16 % or he would have to invest Rs. 160 at 10% to achieve same goal.
Another example of Compounding interest,
Mahesh and Navin are friends, when they came out of the college at age of 20, Mahesh set aside Rs. 2000 every month at compounding interest of 10% annually and invested for 10 years. After getting married he stopped further investments.
Navin set aside Rs. 2000 every month at the simple rate of interest of 10% when Mahesh stopped. Navin did that for 30 years till the age of 60. Navin saved Rs. 720,000 in 30 years. Whereas Mahesh was only Rs. 240,000.
When both retire who will have more money? It would seem to be Navin as he has been saving for 30 years. In reality it was Mahesh. At 60, Mahesh got Rs. 27,79,157 (240,000 + 2539,157) while Navin got Rs. 18,36,000 (720,000 + 1116,000) This is power of compounding which investors normally forget.
On your borrowing financial Institute charges you compounding interest every month or quarterly. The banks and other financial companies make high profit due to only compounding interest method.
If you need help on calculating compounding interest, I have download here for excel file.
Download : InterestCalculator VER31
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