For 13-year-old Rohan, compound interest was merely a mathematical concept that he had\nto remember the formula for in order to ace his\nexam. However, fast forward to a decade later, and Rohan, now 23, sees compound interest as his\nnew best friend. He had recently decided to cash in his first paycheck and take\nbaby steps into the world of mutual fund investments. What drew him to this\nparticular long-term\ninvestment product was the benefit of the power of compounding.<\/p>\n\n\n\n
Curious to know what this is all about? Let\u2019s begin at the\nbasics.<\/p>\n\n\n\n
What is compounding?<\/strong><\/p>\n\n\n\n Compounding is a process that can magnify your returns\nexponentially over a long period of time. With compounding, the interest that\nyou earn on your initial investment is reinvested along with the principal\namount. Effectively, this means that you earn interest on your interest. Unlike\nsimple interest, where your initial investment remains fixed and your interest\nis not reinvested, compound\ninterest is applied on the earnings or gains as well.<\/p>\n\n\n\n To explain this more clearly, let\u2019s take a look at an example\ncomparing simple and compound\ninterest. Say you have invested Rs. 1,000 in investment option A, which\ngives you 10% simple interest, and another Rs. 1,000 in investment option B, which\ngives you 10% compound\ninterest. Here\u2019s how your investment in both these cases will grow after\n2 years.<\/p>\n\n\n\n So, as you can see, the interest keeps on increasing in case 2,\nsince the earnings are again invested back into the product. In the second year\nalone, you earn Rs. 10 more from compounding. This is what happens in mutual\nfunds, where a profitable cycle is created in order to help your earnings grow\nexponentially. You can invest in mutual funds through the Moneyfy app from Tata\nCapital and experience first-hand how the power of compounding can help your\nmoney grow. <\/p>\n\n\n\n The frequency of compounding can vary from one fund to another.\nSome commonly used frequencies include annual, semi-annual, quarterly, or\nmonthly compounding. In some cases, there is even the possibility of daily\ncompounding, wherein your earnings are reinvested on a daily basis. This allows\nyou to take maximum advantage of the power of compounding.<\/p>\n\n\n\n\n Particulars<\/strong>\n <\/td> \n Investment option A<\/strong>\n (simple interest)<\/strong>\n <\/td> \n Investment option B<\/strong>\n (compound interest)<\/strong>\n <\/td><\/tr> \n Rate of interest\n <\/td> \n 10% simple interest\n <\/td> \n 10% compound interest\n <\/td><\/tr> \n Initial investment for year 1\n <\/td> \n Rs. 1,000\n <\/td> \n Rs. 1,000\n <\/td><\/tr> \n Interest for year 1\n <\/td> \n Rs. 100\n (10% of Rs. 1,000)\n <\/td> \n Rs. 100\n (10% of Rs. 1,000)\n <\/td><\/tr> \n Capital at the beginning of year 2\n <\/td> \n Rs. 1,000\n <\/td> \n Rs. 1,100\n (since the interest component is reinvested)\n <\/td><\/tr> \n Interest for year 2\n <\/td> \n Rs. 100\n (10% of Rs. 100)\n <\/td> \n Rs. 110\n (10% of Rs. 1,100)\n <\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n