A simple trick that has made people richer and richer without putting in any extra effort is nothing but the power of compounding. Compounding is an invention considered to be the 8th wonder of the world.

Here we have explained the power of compounding that can change lives if done effectively and patiently. All it takes is patience for the first few years and after that, the wonders are visible and would not let you quit the plan.

What is Compound Interest?

This is the very basic thing which we learn in our school but the application part we tend to forget. Compound interest is nothing but interest on interest. It is just a bit different from simple interest but creates a huge difference in the long run.

Let’s take an example, Mr. Dharmu invested Rs 10,000 in Fixed Deposit for 5 years at a simple interest of 5% per annum in 2015. So, in the year2020, when the 5 years are over, he should get an amount of Rs 12,500 (10,000 + 10,000 x 5% x 5 years). This makes an absolute return of 25% in 5 years (2500/10000).

Now, there is another plan where the same amount is invested for the same period of time and the same rate of interest but instead of simple interest if it is compound interest would change the game.

Calculation of Compound Interest (Table 1)

As per the Compound Interest, an investment of 10,000 becomes Rs 12,763 in 5 years giving an absolute return of 27.63% (2763/10000). Here, a rate of just 5% it made a difference of 2.63% in just five years. Imagine if the amount invested is big this 2.63% would also be huge.

Power of Compounding

The compounding that we get with an investment multiplies the principal amount over a less period of time as the investment period rises. This can be understood with an example of investment. Let’s say, there is a mutual fund offering a 12% annual rate of return which most mutual funds offer. An investment of Rs 1,000 at the beginning of every month is what we are considering here.

Investment of Rs 1,000 per month @12% for 5 years (Table 2)

And, this calculation would continue for any number of years. An investment of Rs 1,000 per month for 30 years is mere Rs 3,60,000 in absolute terms but a 12% compounding rate makes it Rs 35 Lakhs.

It sounds surprising but it’s just the power of compounding where we have taken a rate of return of only 12% which is very minimal to consider.

How to Calculate the Future Value of an Investment?

Here in the above table, we have given a calculation of 1,000 per month with a rate of 12%. Your investment would definitely be different according to the income and it’s possible that you might get a different rate of return also. So, how to find out the amount of future value it would generate after a certain period of time?

So, firstly you can use a formula and calculate the future value in your calculator or take the help of an excel sheet. The formula that you will use in your Calculator is as follows:

Or you can use a simple excel sheet as shown in table 1. and keep on expanding.

Apart from these if you just simply search Future Value calculator on Google you will get a lot of websites to do that. And, that’s the simplest and smartest way out to see the power of compounding.

Click here to use the Future Value Calculator from Casio