Mar 8, 2024
By: ET Online
How compounding works
While simple interest is calculated on the principal amount or the money you have invested, compound interest is calculated on the principal amount and the interest that you earn on that. Compounding is the process where you earn interest on already accumulated interest.
Image Source: ET Online
The 8-4-3 rule of compounding
You can simply follow the 8-4-3 rule of compounding to grow your money. For instance, if you invest a lump sum of Rs 21,250 every month in an instrument that earns 12% interest per annum and is compounded yearly, you will get your first Rs 33.37 lakh in eight years.
Image Source: ET Online
Magic of compounding- 1
It will take only half the time, i.e., four years, for the next Rs 33 lakh. To save the third Rs 33.33 lakh, it will take you only three years. So, in 15 years, you can save Rs 1 crore.
Image Source: ET Online
Magic of compounding- 2
At the end of the 21st year, you will save Rs 2.22 crore — it takes only six years to double your Rs 1 crore to Rs 2 crore.
Image Source: ET Online
Magic of compounding- 3
By the time you reach the 22nd year, it will just take one year to accumulate Rs 33 lakh, thanks to compounding. Do keep in mind here we take annual compounding, that is interest is calculated once a year.
Image Source: ET Online
Choose the frequency of compounding wisely
While many schemes offer annual compounding of interest there are schemes where interest is calculated more than once a year. For instance, if you invest in a bank FD, the interest is compounded quarterly.
Image Source: ET Online
Start early
Starting early will give you the time to take advantage of compounding. The more time you have, the more returns you will get. And you have to invest every month without fail.
Image Source: ET Online
Thanks For Reading!