Compound Interest: How Rs 2 lakh can grow to Rs 20 lakh; how 1-year interest becomes more than total investment

Compound Interest: Compound interest works magically, as it may increase your investment at a much faster rate than normal interest. While normal interest applies only to the initial principal amount, compound interest applies to the initial principal as well as accumulated interest from the previous interest. To put it in simpler words, your return after the first interest cycle becomes your principal for the next cycle. Fixed deposits, equity mutual funds, Public Provident Fund (PPF), Equity-Linked Savings Scheme (ELSS), National Savings Scheme (NSC) and National Pension System (NPS) are some of the popular investment schemes that offer compound interest. Compound interest increases faster as your investment gets older. 

If you stay in your investment for a long period, there comes a point when your interest for just one year surpasses your total investment. 

And one doesn't need to invest large amounts in investments offering compound interest to build a huge corpus. 

A small investment of Rs 5,000 a month may help you generate a Rs 1 crore corpus through compounding. 

We will tell you how your small investments can grow manyfold with compounding, even if you get modest returns, and how one-year interest can surpass your total investment in that scheme. 
But before that, through calculations, understand how compound interest works.

Compound interest calculations

If you invest Rs 2 lakh in a lump sum each in a scheme offering simple interest and compound interest, get 10 per cent annual interest on each, and withdraw money after 10 years, here is what your investment returns will look like-

When you get simple interest

In the simple interest scheme, you will earn Rs 2 lakh as interest, and your total maturity amount will be Rs 4 lakh.      

When you get compound interest

The compound interest in such a scheme will be Rs 3.19 lakh, and the maturity amount will be Rs 5.19 lakh.

If you don't withdraw this amount for the next five years, then after 10 years-

The simple interest rate scheme will give you a total amount of Rs 5 lakh, but the money in the compound interest scheme will grow to Rs 8.35 lakh. 

So, the longer you stay in the compound interest scheme, the more you get.

How money grows faster as investment grows older

The longer you stay in a compound interest scheme, the faster your money grows. 

E.g., if you invest Rs 10,000 a month for 10 years in a scheme offering 10 per cent compound interest, then after 10 years, your investment will be Rs 12 lakh, the interest will be Rs 1123391 (Rs 11.23 lakh), and the total gains will be Rs 2323391 (Rs 23.23 lakh). 

But if you stay in the same investment for five years more, you will invest just Rs 6 lakh extra, but your compound interest will be Rs. 3245760 (Rs 32.5 lakh), and the total returns will be Rs 5045760 (Rs 50.5 lakh).   

How you can get Rs 2.17 lakh compound interest on Rs 2 lakh investment

A longer stay in the compound interest scheme may ensure this. 

E.g. if you invest Rs 2 lakh in a scheme offering 10 per cent compound interest, in the 26th year, your interest from that investment will be Rs 2,16,695 and your maturity amount will be Rs 23,83,636. 

If you get 12 per cent compound interest on that, you can earn over Rs 2 lakh interest on the same amount in the 20th year.  

Compound interest calculations

What is the impact of duration on compound interest investments?

When we calculate compound interest, duration matters a lot. 

Even if your investment amount is lower but the duration is higher than the one with a higher amount and a lower duration, you can earn more than the other. 

E.g., there are two friends, and each of them invests in a scheme that offers 10 per cent compound interest. 

The first friend invests Rs 3000 monthly for 10 years, and the second invests Rs 6,000 monthly for five years. 

Both of them will invest Rs 3.60 lakh total. 

But the first friend with a Rs 3000 investment will get compound interest of Rs 2.44 lakh and a maturity amount of Rs 6.04 lakh. 

The second friend with a Rs 6000 monthly investment will get compound interest of just Rs 1.03 lakh and maturity amount of Rs 4.63 lakh. 

(Disclaimer: Investments are subject to market risks. Do your own research or consult your advisor before investing.)