Compound interest is critical to making money for you. Here is how much

Ever wondered why retirement planners always ask you to start investing early? Or, how your money grows when you invest it in long-term instruments like Public Provident Fund (PPF) or National Pension System (NPS) accounts? What is at work is the miracle maker formula, the humble compound interest that helps grow your money manifold over the years. Compound interest is basically the effect of the interest earned on investment that has earned interest on account of re-investment.

Let's explain this more:

Suppose you invest amount X in an instrument offering 8 per cent interest annually. At the end of the year, suppose you earn interest amount Y (8% of X). Your total money at the end of the year will be = X+Y. Suppose you re-invest the total amount, then at the end of the second year, your total money will become = (X+Y)+ 8% of (X+Y). If you continue the process over the next few years, your total lump sum will also become big as every year your invested amount will be the balance of the previous year and the 8% interest earned on that amount. This effect is popularly called as the compounding effect.  In school, you may have learnt a lot about it. 

The only condition to enjoy the full benefit of compounding effect is not to withdraw the earned interest. Rather, re-invest it along with the principal amount for a longer term. Let's take a look at how your money will grow under the effect of compounding in terms of numbers:

First, a few assumptions. 

You are investing Rs 1,50,000 at 8% interest, which is compounded annually, for three years. 

Here's how your money will grow: 

From the above chart, you can see that the compounding effect can help your initial investment of Rs 1,50,000 grow to Rs 188956.8 in just three years. If you keep invested for the long term, you will be able to accumulate a large lump sum.