Power of Compounding: Total investment Rs 38.40 lakh, interest in 1 year Rs 41.63 lakh! How it is possible; know calculations

Power of Compounding: Compound interest is the interest on interest that increases your income multiple times if you continue your investment for a long period of time. Compound interest is added to your deposited investment at the end of every cycle, monthly, quarterly, and yearly, and the total money becomes your principal for the next cycle. The process is repeated and if you stick to your investment for many years, there comes a point when the interest you earn in a year becomes more than a total investment. 

Power of compounding is such a force that it can make the same investor ordinary, average, and extraordinary just by sticking to the investment for different durations.

When it comes to investment options where one can get compound interest, equity-linked mutual funds, equity-linked saving schemes (ELSS), Public Provident Fund (PPF), fixed deposits (FDs) and life insurance are the prominent ones.

Also Read | Power of Compounding: How your Rs 1.20 lakh can grow into Rs 62.15 lakh, know calculation

"The trick to wealth creation is quite simple: invest small amounts every month in an appreciating asset consistently, and over time it becomes a sizeable fortune. Mutual funds provide an accessible, simple, transparent marked-to-market investment option for Indians to create astronomical wealth this way. ₹5000 invested in an equity SIP generating 12% annual returns becomes ₹4.12 lakh in 5 years, ₹25.22 in 15 years, ₹94.8 lakh in 25 years, and ₹3.24 crore in 35 years. In this period of 35 years, your first SIP instalment of ₹5000 would grow to 2.64 lakh—a 52x growth. All you need is time to let the power of compounding do its trick," said AR Hemant, AVP, Bankbazaar.com.

Compound interest: How one-year interest becomes more than invested money

Scenario 1

If you have invested a lump sum of Rs 1 lakh and the rate of return is 10 per cent annually, in the first year, you will earn Rs 10001 from the interest, and your total balance value will be Rs 1,10,001.

Since you are getting compound interest on your investment, Rs 1,10,001 will become your principal for the next year and you will get a 10 per cent return on this amount.

In the second year, you will get an interest of Rs 11,001 and your principal will be Rs 1,21,001.

So, in the 10th year, your interest in a year will swell to Rs 23,580, the total interest will be 159,375, and the total balance value will be Rs 2,59,375.

At this stage, you can see that you got Rs 10,001 as interest in the first year, but in the 10th year, you got Rs 23,580.

The difference will be more striking as time passes.   

Fast forward to the 20th year, you will get Rs 61,160 as interest in the year; your total interest will be Rs 5,72,750, and the maturity amount will be Rs 6,72,750.

Moving forward to the 25th year, you will earn an interest of Rs 98,498, the total interest will be Rs 9,83,471, and the total investment value will be Rs 10,83,471.

At this stage, if you stick to just one more year, or to the 26th year of investment, you will get Rs 1,08,348 just as interest, which is precisely Rs 8,348 more than the total investment 26 years back.

In the 26th year, your total interest will be 10,91,818 and the investment value will be Rs 11,91,818. 

Here, a 10 per cent return is a modest approach.

Investment options such as mutual funds have given an annualised return of 12 per cent in the last few years.

If you get more interest on your return, you can achieve your target of getting more interest in a year than the initial invested money much earlier.

How Compound Interest Work: Scenario 1

Scenario 2

Here, we go with a monthly SIP of Rs 10,000, where the rate of interest will be 12 per cent.

Your deposit in a year will be Rs 120,000, and you will get Rs 7,665 in interest, and your total balance will be Rs 1,27,665.

In the second year, your total deposit will be Rs 240,000, the interest in the year will be Rs 22,985, the total interest will be Rs 30,650, and the total balance value will be Rs 2,70,650.

In the 10th year of investment, the invested money will be Rs 12 lakh, the interest will be Rs 2,34,026, the total interest will be Rs 10,40,359, and the total investment value will be Rs 22,40,359.

In the 15th year of your investment, the total investment will be Rs 18 lakh, the interest in the year will be Rs 5,03,914, the total interest will be Rs 29,59,314, and the investment value will be Rs 47,59,314. 

In the 20th year, your investment will be Rs 24 lakh, the interest in the year will be Rs 9,79,549, the total interest will be Rs 67,98,574, and the total investment value will grow to Rs 91,98,574.

In the 25th year, your investment will be Rs 30 lakh, the interest in the year will be Rs 18,17,780, the total interest will grow to Rs 1,40,22,006, and the total investment value will be Rs 1,70,22,066. 

In the 30th year, with a total investment of Rs 36 lakh, you will get Rs 32,95,030 as the interest in the year; the total interest will grow to 2,72,09733, and the investment value will be Rs 3,08,09,733.

The 32nd year will be the year when your interest in a year will surpass your total investment in 32 years.

In the 32nd year, your investment will be Rs 38,40,000, while you will earn Rs 41,63,813 in interest in the year.

The total interest in 32 years will thus become Rs 3,50,78,378 and the investment value will become Rs 3,89,18,378.

In the first scenario, at a 10 per cent rate, the interest in the year became more than the invested amount in 26 years.

While in the second scenario, at 12 per cent, it the interest in a year became more than the invested amount in 32 years. 

Either way will help you grow your investment many fold, but here the question is: at a time when investment turns manifold in a few years, who waits for 26 or 32 years to get an annual interest that surpasses your investments?

But that's the logic behind investing early.

If you start investing at the age of 25 rather than in your late 30s, you have fair chances of accumulating huge wealth by your early or mid-50s.

Investing Rs 1 lakh one-time or Rs 10,000 a month for your retirement can be a good option. The longer you stay in your investment, the more you earn through compound interest.

How Compound Interest Works: Scenario 2