The Power of Compounding: A Handy Guidebook

Mumbai: Albert Einstein famously stated, “Compound interest is the eighth wonder of the world. He who understands it, earns it. He who doesn’t, pays it.”

Time plays an imperative role in wealth creation. Sadly, most people fail to understand the rule of wealth creation— investing early to reap the compounding effect.

The basic principle of compounding is that you can earn interest even on the interest earned. In the simple words, compounding is the addition of interest to the principal value of the investment. Further, the added interest becomes the part of the principal amount and also generates return for you. This addition of interest is called compounding. The benefit of compounding works better over the period of time. It means, the longer the tenure of your investments, the more money you can accumulate because of the compounding effects.

How does it work?

Let’s look at the following example to understand the power of compounding.

Rajiv and Amit both are earning Rs 50,000/monthly. Rajiv understands the power of compounding and has started investing early at the age of 25 years with a detailed systematic approach in order to meet his financial goals. On the other hand, Amit is a spendthrift and thus, starts investing at the age of 40 years. Let us see how much they will get on their retirement if they both are planning to retire at the age of 60 years.




Present Age

25 years

40 years

Retirement Age

60 years

60 years

Monthly Income

Rs 50,000

Rs 50,000

Regular monthly investments

Rs 10,000


Assuming Interest Rate



Compounding Interval



Total Corpus at 60 years

Rs 22,332,258

Rs 11,861,501

Principal Amount

Rs 4,200,000


Interest Earned

Rs 18,132,258



Even when Amit is investing twice the amount what Rajiv is investing, he will not build a huge retirement corpus as compared to his friend.

Also, the graph below clearly illustrates the compounding effect. The corpus amount is directly proportionate to the years of investment. The corpus amount starts increasing slowly and when the compounding takes over; the extra time means more wealth.


Therefore, it is strongly advised to start investing early to enjoy the power of compounding. However, even if you are above 40 or 45 years of age, you can still start investing to build a corpus for your future requirements. Although, the corpus would not be so huge but still it is better to have something than nothing!

Some key takeaways

ü  Invest early

ü  Stay invested for a longer tenure

ü  Have a well-diversified portfolio

Where to invest

Choosing the right investment avenue is the part of successful financial planning. However, given the options available in the market, an investor with limited financial know-how will be bogged down.

Therefore, before choosing any asset class, one should consider its risk appetite. For instance, equity is more risky than debt funds, and therefore, should not be selected by investors with low risk appetite. Similarly, for risk-averse investors, recurring deposits are the right investment option.

Investing early will help designing the financial portfolio as one can take more risks. When you start investing at an early age, your financial obligations may be low, and therefore, you can take more risks and thus, park a major chunk of your funds in equity funds. However, towards a later stage of life when financial obligations get increased, one should invest in debt-oriented investment options to curtail the impact of market volatility.

Start investing now even if it is of a low value and reap the benefits of power of compounding. 

Posted by on January 23, 2016. Filed under Economy. You can follow any responses to this entry through the RSS 2.0. Both comments and pings are currently closed.