Ever wondered if you can save enough for your retirement days, or when’s the right time to start saving in order to save enough for a rainy day? The simplest answer to these questions is, making your money work for you. Most of us are aware of the concept of saving early and that it proves helpful in creating such wealth. But do we know what powers this growth? Compound interest is what drives this exponential rise in your money. So, what’s compound interest and how does it work? Let’s find out!
Compound interest is nothing but the interest that you would earn on interest. Compound interest helps you get considerable growth in your investment over a course of time. Wondering how this happens? Compound interest works by taking into consideration your principal amount and the interest you’ve earned so far.
Let’s take an example to understand this better:
Ajay had ₹100 in his bank account with a 5% interest per annum. After a year, his balance is ₹105 and the same goes to ₹110.25 in a 2-year time span. Now, this is exactly what compound interest does to his money! Along with the ₹5 of annual interest, Ajay starts earning interest on his interest too. So, he has not only earned an interest of ₹10 for years 1 and 2 but also a ₹0.25 interest on his interest over this time period. That’s the power of compounding!
“Compound interest is the eighth wonder of the world. He who understands it earns it … he who doesn’t … pays it.” – Albert Einstein
Now you know what this famous line quoted by Albert Einstein actually means. Further, let’s dive deep into how this concept opens doors for you to multiply your savings.
The power of compounding depicts a snowball effect, where it explains how small and periodic actions carried out over a period of time can lead to exponential results. The secret of substantial growth in your finances through the power of compounding lies in the time the money is invested for. The longer you invest, the more you earn and save!
How to Make it Work for You: Quick Tips
If you want your money to work for you, you have to let it be invested for a longer time to ensure that the magic of compounding works benefits you. And the earlier you begin, the longer you stay invested. So, start as early as you can and multiply your money!
Build your investment base by circulating your earnings. If you are someone who owns shares in stocks or invests in mutual funds, you could be able to invest your dividends into more shares. This way, you could compound your returns and start a passive income stream.
One of the most timeless pieces of advice we have heard includes ‘Do not put all your eggs in one basket. It holds through for investments too. You must have an investment portfolio that includes diverse financial products as per your risk appetite and investment goals. This way, you do not lose out on all your money, in case of a wrong turn. Investment options like ULIPs and Mutual Funds allow you to do just that!
When it comes to saving for your financial goals, putting together a strategy as per your needs is very important.
Compound interest lets you leverage your financial strategy by multiplying your savings over time, hence, compound interest is a best friend to your savings.