What is Power of Compounding & How does it Works | SBI Life
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All you need to know about compounding and its benefits

Insurance Basics & Financial Advice 'Compounding' is a process wherein the capital gains or the profit are reinvested to generate additional income. The growth of your investment is exponential as interest is earned from the principal as well as the additional earnings accumulated over the past period.
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All you need to know about compounding and its benefits

5 Minute |

Power of compounding
'Compounding' is a process wherein the capital gains or the profit are reinvested to generate additional income. The growth of your investment is exponential as interest is earned from the principal as well as the additional earnings accumulated over the past period.
 
 
How does it work?
When compounding, the first year's interest is added to the principal amount. Now the principal amount for calculating interest for the second year is higher than the first year. Thus the interest would be more. In this manner, every year, the earnings over the principal amount will continue to increase.
 
For example-
You invested Rs. 50,000 today in a financial instrument that compounds interest at 10% annually. After 20 years, this investment will yield you returns of 3.36 lakhs.
 
The power of compounding is immense. It can help you earn from your savings. So how can you take the benefit of compounding? Read on to know.

 

Start early.

If you want to make the best use of compounding, you should start early. The longer the investment period, the better are the chances of significant returns. A longer time period will earn you more profits due to the compounding effect. This is why you should start your financial planning as early as possible and let compounding work for you. Investing early ensures that you have a sizeable corpus at the time of your retirement. Also, in case of some eventuality, your family and dependents will have something to fall back on.

 
Invest thoughtfully
The rate of interest significantly impacts your investment returns. Higher the investment rate, the better are your earning prospects. The rate of interest makes a significant difference in the long term.

 

Let us consider the same example as above.

If you consider the same principal amount with the interest rate at 7%, the total amount at the end of 20 years will be around 1.9 lakhs, which is almost half of the amount at 10% interest rate.

However, when the same amount is invested at a 14% rate of interest, it would be around 6.87 lakhs.

You can see how a small change in the rate of interest can significantly impact your returns. It is thus advised to plan, research and then make an investment carefully.

 

Grow your investment.
The returns are directly proportional to your investments. The more you invest, the better are your chances of earning. However, this is one aspect that is often overlooked in investment planning. Income, as well as savings of an individual, grow over time. However, there is no change in the investment amount. Financial institutions offer you the option of increasing your investment with time. This is a golden opportunity to increase your returns from the investment with time.
 

Invest regularly.
Alternatively, to address your changing financial goals companies offer you the option of opting for a plan with better features by paying higher premiums within the policy term itself so that you don’t have to go through the hassles of purchasing and paying premiums towards a new plan.

Do your research before deciding on an investment avenue. Do not be misled by advertisements and tall claims made by the salespersons. It is always advisable to conduct your research regarding the risks and other terms and conditions of the investment you will be making.

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