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Kotak e-Invest
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Ref. No. KLI/22-23/E-BB/492
The power of compounding is a great way to get good benefits as it provides returns on returns.
Earnings, saving, paying taxes, and investing are all part of financial planning, and compounding plays an important role. When you start earning, you realize how important financial management is, and compound interest significantly impacts it.
In financial terms, compounding means earning interest not just on your initial investment but also on the interest that accumulates over time. The power of compounding is the phrase used explain the extend of growth you can expect on your investments when put in a smart savings plan. In Compound interest, the total amount at the end of an interest cycle is taken as principal amount to next cycle.
For example, let’s say you invest ₹1,000 at an interest rate of 10% per year.
At the end of 1st year, 10% interest = ₹100.
Which makes total = ₹1100.
For second year, your investment will be ₹1100, the same 10% interest rate.
At the end of second year, interest = ₹110,
So total = ₹1210.
As the years go by, this growth continues, by accumulating interest on growing principal amount. This is the power of compounding—where even small amounts can grow significantly over time, creating a powerful tool for building wealth.
Compounding is the annual reinvestment of earnings at the same rate of return to grow the principal amount. Compounding is an intriguing notion. This is because the interest on your invested funds also collects interest. This is referred to as compound interest. The investment’s value grows at a geometric rate (constantly increasing) rather than an arithmetic rate (straight-line). Reinvesting earnings at the same compound interest rate of return would aid in the growth of the principal year after year.
Compound interest is used when the principal includes the accrued interest from prior periods, and interest is calculated on this. Investors can use this strong tool (compound interest) to plan their financial goals. This method will help the investor in the long run. The longer the investment horizon, the bigger the returns. The best advice is to start saving and investing regularly. An early start would give the investor a greater compounding effect, making wealth creation easier. Compound interest has many applications. It only increases returns over time, and the investment rises exponentially.
Compounding is the process through which the returns on an investment are reinvested to generate further revenues over time. In a nutshell, compounding is interest on interest, which magnifies rewards over time. The power of compounding uses this notion to evaluate the worth of an investment.
The Power of compounding calculator is a tool for determining the value of an investment. It computes the value of an investment after ‘n’ years at a certain interest rate. The compound interest formula is the foundation for the power of the compounding calculator. The entire notion of compound interest centers upon earning significant returns by compounding the interest earned on the principal amount.
In the power of compounding calculator, the compound interest formula is:
CI = P(1 + r/n)nt
Where,
CI= Compound Interest
P = Principal
r = Interest Rate, and
n = Number of Periods
t = Time Period
The calculator assists in determining how much you will earn if you invest a set amount for a set period at a fixed annual interest rate. This calculator can be used to calculate the possible returns on investment.
Generally speaking, compounding refers to the simple concept of earning returns on a return. This means that the longer you invest, the more money you accumulate. Let’s assume you’ve invested ₹5,000 at an interest rate of 5%, to be compounded annually. In the first year, you will earn ₹250. This will be added to your principal amount the next year. So even without you adding more money, your investment amount in the second year is ₹5,250. At the end of the year, you will earn 5% on the new amount, and so on.
When it comes to investment planning, compounding is the way to go. It allows you to build up a large corpus of funds. However, there is one important factor that you need to consider. For compounding to work for you, you need to have time on your side. We can illustrate this better with the help of an example.
Suman and Sagar both joined a new firm recently. They’ve been hired at the same level, earning a monthly salary of ₹50,000. While Suman tends to spend almost her entire salary every month, Sagar is a bit more prudent. He invests ₹3,000 every month in a compounding fund for five years. At the end of his investment plan, Sagar would have accumulated ₹2,52,909.
| Sagar | |
| Monthly Investment (₹) |
3,000 |
| Assumed rate of return (Compound Annual Growth Rate - CAGR) |
12% |
| Investment timeline (months) |
60 |
| Ending Investment Value(₹) |
2,52,909 |
After seeing her friend do so well, Suman also decides to start investing like Sagar. Unfortunately, she started two years after him. Even though she invests the same amount, Suman will accumulate only ₹1,34,815 at the end of three years. Suman would have lost ₹1,18,094 simply because she started two years too late. Apart from missing out on the returns she would have accumulated for the period, she also missed out on the opportunity to reinvest those returns into her investment and earn more.
| Sagar |
Suman | |
| Monthly Investment (₹) |
3,000 |
3,000 |
| Assumed rates of return (Compound Annual Growth Rate - CAGR) |
12% |
12% |
| Investment timeline (months) |
60 |
36 |
| Ending Investment Value (₹) |
2,52,909 |
1,34,815 |
| Suman made the mistake of starting two years later, which cost her (₹) |
1,18,094 |
In order to play catch up, let’s assume that Suman starts to invest ₹4,000 per month instead of ₹3,000. Let’s see how much of a difference that would make.
| Sagar |
Suman | |
| Monthly Investment (₹) |
3,000 |
4,000 |
| Assumed rates of return (Compound Annual Growth Rate - CAGR) |
12% |
12% |
| Investment timeline (months) |
60 |
36 |
| Ending Investment Value (₹) |
2,52,909 |
1,79,754 |
| Suman made the mistake of starting two years later, which cost her (₹) |
73,155 |
Despite increasing her initial investment amount, Suman still fails to earn as much as Sagar.
To get the most out of compounding, you should begin investing early and consistently. Compounding allows you to earn interest on interest over time. One way to do it is by making regular contributions to increase your principal and let your earnings be reinvested. This creates a snowball effect, allowing your savings to grow at an increasing rate. The power of compounding allows you to give your money a chance to multiply on its own.
Several other strategic actions can also improve saving and the power of compounding can be witnessed through the following:
You should begin investing as soon as possible because the earlier you invest, the more your money grows.
There are various ways to invest. You must choose the method that yields the highest returns. One option is the old, simple method of investing your money and earning returns. But what if there is a way to earn returns on both initial investments and collected earnings? Smart, right? It is called compounding; it allows you to earn interest on interest.
Top up your investment regularly to boost your savings by increasing the amount that benefits from compounding. Each additional contribution increases and generates interest for you.
These schemes, like fixed deposits or bonds, provide guaranteed interest rates and protect the principal amount. To maximize compounding benefits, consider investing in equities. Debt funds with fixed returns from securities are a lower-risk option.
Select investments with higher returns (depending on your risk-appetite), to achieve your financial goals faster because these options accelerate the compounding process, allowing your savings to grow at a faster rate.
No investment can compensate for the lost time. Even the smallest of delays can stop you from using the power of compound interest. When Suman started investing just 2 years after Sagar, she ended up with ₹1,18,094 less than Sagar at the end of the investment term.
If you’d like to utilize compounding investments at full potential, you can consider putting your savings in fixed deposits, life insurance, and mutual fund schemes. If you’d like to understand how much money you can expect to earn at the end of your stipulated tenure, you could use a power compounding calculator, which can be found online. Please remember that all investments inherently have some risk, so you must educate yourself about all the risks before finally putting your money down.
Among all investment possibilities in India, this is one of the most secure long-term investment options. It is exempt from taxation. A PPF account can be established at any bank or post office. The money invested is locked in for 15 years. Furthermore, this investing choice lets you receive compound interest on your amassed funds. You can extend the time frame for the next five years. The sole disadvantage of holding a PPF account is that you cannot withdraw the invested funds until the conclusion of the sixth year. If you require funds, you can borrow against the balance of your PPF account.
NSC is a popular government-backed savings option that offers guaranteed returns and tax benefits. It is a safe investment that may be made at any post office for a period of five years. The government sets the interest rates on NSC, which are revised every quarter. However, once your investment is made, the interest rate does not alter during the tenure of the NSC. Currently, your investment in NSC yields 6.80% compounded every six months.
A minimum investment of ₹500 is permitted in NSC, with no upper limit. The best part is that you can deduct taxes up to a limit of ₹1,50,000 under Section 80C. Remember that the interest generated on NSC is taxable; thus, you must include the interest earned on NSC in your overall income when filing your taxes.
The Post Office Monthly Income Scheme, as the name suggests, is a scheme that allows you to save money every month and is governed by Post Offices in India. A government-backed initiative that allows consumers to save money every month. Any Indian person can easily register a Post-office MIS account with a minimal deposit of ₹1500. The maturity time of the scheme, which is 5 years, begins the day the account is opened. Investors can open a POMIS account either individually or collectively. Any investor searching for a tax-saving alternative should avoid this tool because it does not provide any tax rebate on the maturity or investment amounts.
The golden rule of wise investment is to be thoroughly aware of the many possibilities available in the market. Most investors’ investment goals differ depending on their financial objectives, time horizon, and risk tolerance, among other factors. To grow money, you must invest in clever investment options that provide lucrative long-term returns.
Also, as an investor, you must distinguish between savings and investment. While saving is regarded as an aloof wealth accumulation strategy, great investment tactics can help you create more assets.
1
The power of compounding is the process by which earnings from an investment generate additional earnings over time, resulting in exponential wealth growth.
2
In a savings account, compounding occurs when you earn interest on the principal amount and then earn additional interest on that interest. This can increase your savings exponentially.
3
Investing early is crucial because the longer your money is invested, the greater the returns will be because of the power of compounding.
4
Savings accounts, long-term investments, PPFs, and fixed deposits are some of the investments that benefit from compounding.
5
Compounding significantly boosts retirement savings by reinvesting returns, leading to exponential growth.
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Amit Raje is an experienced marketer who has worked in various Fintechs and leading Financial companies in India. With focused experience in Digital, Amit has pioneered multiple digital commerce in India. Now, close to two decades later, he is the vice president and head of the D2C business department. He masters the skill of strategic management, also being certified in it from IIMA. He has challenged his challenges and contributed his efforts in this journey of digital transformation.
Prasad Pimple has a decade-long experience in the Life insurance sector and as EVP, Kotak Life heads Digital Business. He is responsible for developing user friendly product journeys, creating consumer awareness and helping consumers in identifying need for life insurance solutions. He has 20+ years of experience in creating and building business verticals across Insurance, Telecom and Banking sectors
In this policy, the investment risk in the investment portfolio is borne by the policyholder.
Kotak e-Invest
Features
Ref. No. KLI/22-23/E-BB/521
The information herein is meant only for general reading purposes and the views being expressed only constitute opinions and therefore cannot be considered as guidelines, recommendations or as a professional guide for the readers. The content has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Recipients of this information are advised to rely on their own analysis, interpretations & investigations. Readers are also advised to seek independent professional advice in order to arrive at an informed investment decision. Further customer is the advised to go through the sales brochure before conducting any sale. Above illustrations are only for understanding, it is not directly or indirectly related to the performance of any product or plans of Kotak Life.
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