Let us take a small example: If we invest ₹100 now, we get ₹10 as interest for this year and our investment grows to ₹110. But the next year, the interest we get is 10% of ₹110 i.e. ₹11. So, we get interest not only on our principal amount (₹100) but also the interest (₹10) we have earned so far. This interest keeps on increasing as the value of our investment increases.
The effect of compounding can be seen through the following example, where we have considered four scenarios:
Rate of return has been assumed to be 10%.
| A | B | C | D | |
|---|---|---|---|---|
| Starting age | 25 years | 30 years | 35 years | 40 years |
| Monthly investment | ₹ 8000 p.m. | ₹ 10000 p.m. | ₹ 13333 p.m. | ₹ 20000 p.m. |
| No. of years invested | 25 | 20 | 15 | 10 |
| Total amount invested | ₹ 24 lakhs | ₹ 24 lakhs | ₹ 24 lakhs | ₹ 24 lakhs |
| Accumulated amount at 50 years | ₹ 99.45 lakhs | ₹ 72.39 lakhs | ₹ 53.55 lakhs | ₹ 40.29 lakhs |
You can see how investing the same total amount but for different time periods can lead to highly varying returns.
If you are still not convinced, look at our 2nd example:
Here, A started investing at age 25: ₹ 1 lakh every year for 10 years. He keeps his money untouched till age 65
B invests from age 35 (10 years late): ₹ 1 lakh every year for 30 years.
| A | B | |
|---|---|---|
| Starting age | 25 | 35 |
| Yearly investment | ₹ 1,00,000 | ₹ 1,00,000 |
| No. of years put in | 10 | 30 |
| Total amount invested | ₹ 10 lakhs | ₹ 30 lakhs |
| Rate of return | 10% | 10% |
| At the age of 65 years | ₹ 3.06 crore | ₹ 1.81 crore |
As you can see, B’s investment is 3 times that of A, but A’s corpus has accumulated to ₹3.06 crore whereas B’s corpus stands at ₹1.81 crore.
This shows how lesser but early investments accumulate to larger amounts than higher investments later on. A gap of just 10 years makes a large difference to your corpus.
Compounding gets really great when it teams up with time. Investing early is the key to wealth creation.
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