What is Compounding?||Power Of Compounding||

Introduction: What is Compounding?

• Compounding refers to the process where the returns generated by an investment also start earning returns over time.
• Unlike simple interest, where interest is earned only on the principal amount, compounding helps grow both the principal and the returns exponentially.

Albert Einstein

1. "Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn't, pays it." This famous quote highlights the exponential power of compounding and its potential to grow wealth over time.
2. "Compound interest is the most powerful force in the universe." Einstein emphasizes the incredible impact compounding has when applied to finances and investments.

Warren Buffett

1. "My wealth has come from a combination of living in America, some lucky genes, and compound interest." Buffett attributes much of his financial success to the consistent application of compounding over decades.
2. "Do not underestimate the power of compounding, even if the initial amounts seem small." He advises starting early and being patient to see compounding work its magic.
3. "The best investment you can make is in time. The power of compounding grows exponentially over time." Time is the most critical factor in making compounding work.

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Jeff Bezos

1. "If you double a penny every day for 30 days, by day 30, you’ll have over $5 million. That’s the power of compounding."

Why Compounding is Powerful

• The exponential nature of compounding means your money grows faster as time progresses.
• It turns time into a significant asset. The earlier you start investing, the more pronounced the compounding effect.

Example: If you invest ?10,000 at 12% annual returns, your investment will double approximately every 6 years (Rule of 72).

• After 6 years: ?20,000
• After 12 years: ?40,000
• After 18 years: ?80,000
• After 24 years: ?1,60,000

Notice how the growth accelerates in later years. This acceleration is the essence of compounding.

2. How Compounding Works in Mutual Funds

Mutual funds provide an ideal platform for compounding because of their design. Here’s how:

Reinvestment of Returns

• Equity Funds: Capital gains and dividends are reinvested into the fund, enhancing the compounding effect.
• Debt Funds: Interest income is reinvested, increasing the corpus over time.

Systematic Investment Plans (SIPs)

• SIPs allow you to invest fixed amounts regularly, enabling you to take advantage of compounding without worrying about market timing.
• Every SIP installment grows over time, contributing to a larger final corpus.

Example of SIP Growth

Let’s assume you invest ?5,000 monthly in a mutual fund with an average annual return of 12%. Here’s how compounding works over different time horizons:

• 10 Years: ?11.6 Lakhs (Invested ?6 Lakhs)
• 20 Years: ?49 Lakhs (Invested ?12 Lakhs)
• 30 Years: ?1.76 Crores (Invested ?18 Lakhs)

The longer you stay invested, the more pronounced the compounding effect becomes.

3. Factors Affecting the Power of Compounding

To maximize compounding, you need to understand its driving factors.

Time Horizon

• The longer you remain invested, the more exponential your growth becomes.
• Starting early can make a massive difference, even with smaller investments.

This is only For Educational Purpose.

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